I, Bank (or When Computers Take Over Wall Street)

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This is a guest post written by Adam Braus.  Adam blogs about Fiscal Localism and Universal Banking over at One Is Not Enough

Computers Are Taking Over Wall Street

Who wouldn’t give up their social security for a safe and commodious robot like Rosie Jetson? She beeps and boops about the living room, swivels around furniture, does the dishes, takes phone calls, and even makes pathetic attempts to contain George’s shenanigans.

You might ask, What does such a robot have to do with your social security? Well, imagine if Rosie unbolted her bonnet, abandoned her space-age domicile, and wheeled off to the trading floor of the New York Stock Exchange? Would we feel as safe and happy about Rosie buying and selling the securities that back our retirements, mortgages, and jobs as we did about her doing the laundry?  In many ways, Rosie has already been liberated, and started calling the shots in the market.

The publication Advanced Trading estimates that an astounding 73% of equity trading (by volume) is now performed by automated programs, and a market research company, the Tabb Group, estimates that program trading profits amounted to over $21 billion in 2008.

Look Out! Rosie Is Running The Trading Floor

Rosie Derivativater

Computerized, algorithmic trading, also known as high-frequency trading (HFT) or ‘algo’ trading, was a long shot fifteen years ago, but now is a hot commodity on Wall street.

Digital trading kicked off in the 70’s when the New York Stock Exchange put into place its first electronic, real-time trading system. Since then, small dynamic IT trading companies develop and prove their hardware and software performance on the fringe before being absorbed by more mainstream banks and hedge funds. Peter Van Kleef, the CEO of Lakeside Capital Market Services who specializes in electronic trading tools and custom software development and a speaker at the HIFREQ TRADING conference describes the shambling path of this sector’s growth in an interview with Highfrequencytradingreview.com

How it works:

Before Rosie Jetson starts her new career, she needs to be reprogrammed. As an algo robot, she will be doing one of two jobs.

One job of HFT robots is making markets more efficient by maximizing participation and minimizing entrance fees (spreads) for flesh-bag traders. This is called “market making” and is unarguably a “good thing”. The markets, such as the New York Stock Exchange, Nasdaq, etc, provide incentives to banks that want to ‘make a market’ on something. Sometimes they offer a “rebate” to market makers for the volume of trades they make. HFT traders take advantage (in a good way) of these rebates to launch markets that were prohibitively expensive without them. Market making actions are real financial progress and truly grease the skids of capitalism.

The second way HFT is used is not as innocent or transparent as market making. Algo trading is also used to simply buy low and sell high. This is called “flow” or “proprietary” trading depending of if an institution is risking someone else’s or its own money. No one knows how much of this money is driven by robots, but current events back up the rumors that say there is more than meets the optical sensor with robots in the market right now.

Unlike billionaire traders like Warren Buffet or George Soros who use (more or less) Fundamental Analysis to trade–they examining the real growth of productive goods, changes in values, and the moment to moment feelings and intuitions of the market–Rosie is reprogrammed to follow the principles of Technical Analysis.

Her programmer trains her to use prices and financial statistics to predict future price movements. Rosie employs these tools the same way any human trader would employ Rosie, but she can do it quicker and without suffering the nuisance of feelings and hunches. By running her algorithms and trading thousands of times faster than a human can, Rosie beats the crowd of flesh-bag traders every time.

HAL-aburton

The flash crash on May 6th, 2010 is one current event that supports speculations that robots are playing an even larger role than has yet been reported.

On May 6th of 2010 the DOW lost around 1000 points (around 10% of its value) and regained them in under fifteen minutes. Theories of human error dissolved as fast as android skin in acid. As the machines came under scrutiny it came as an epiphany for those on Mainstreet that computers today plan and execute the majority of trades on the open market. Since May regulators have been bearing down on these computer enhanced trading methods, and are due to release full reports some time in September 2010.

In the face of criticism traders, economists, and exchanges are touting the “Rosie” view of the future of algorithmic trading. They say that ever more sophisticated programs could lead to hyper-efficient markets. Theoretically program trading could pave the way to a market with less risk, more jobs, and more prosperity for everyone. They say the programs help to bring about stable interest rates, stable prices, and all-around economic growth.

Observers like Delaware Senator Edward Kaufman who want to investigate and perhaps regulate high-frequency trading worry that computers could be giving a few people an unfair advantage. However, no one is considering the obvious danger that someday soon, a tranquil 16-bit voice will speak out over the New York Stock Exchange and say—I’m sorry traders . . . I’m afraid I can’t do that . . . .

[opening image credit: rednuht – flickr]