Issue #73
Last Update May 10, 2013
 |
 |
 |
 |
 |
 |
 |
 |
 |
 |
 |
 |
Finance High Velocity Trading by Sten Grynir May 30, 2010 The extraordinary volatility of the financial markets, with prices bouncing all over the place from day to day, is not only a deterrent to a full economic recovery, but also a symptom of a systemic flaw in the organization of these markets that someday could lead to disaster. That disaster nearly occurred recently when the stock market plummeted a thousand points before rebounding most of the way scant seconds later. Some of the volatility is generated by unsettled political and economic situations, but some of it is generated by trading technologies not adequately controlled by the exchanges and for which limitations are not even contemplated by the regulatory agencies. High frequency computer generated trades bear a significant responsibility for recent events.
The public maintains this image of exchange trading as being a bunch of guys standing around in a trading ring yelling at each other until a deal is struck, then moving on to the next trade, all very open and all very understandable. The prices bid and asked are thought to be based on information about each company's present situation and future prospects. The reality is quite different. While trading by human beings based on company fundamentals still goes on, much of the activity of professional trading operations such as hedge funds and bank or brokerage proprietary trading desks is algorithmic, based on arcane calculations which amount to little more than extraordinarily sophisticated trend-following models, where the trading is untouched by human hands and operates at blinding speeds and generates incredible trading volumes. When these robots battle each other speed is important; so important that latency (the time it takes a signal, essentially at the speed of light, to get from the trading computer to the exchange's trade-matching computer) matters. The exchanges have accommodated this high velocity trading by allowing traders' computers o be located in or near their server room, to reduce latency.
The danger, of course, is that these robots, churning out thousands of trades in seconds, can follow each other in a death spiral too quickly for human beings whose sense of the market is, one hopes, grounded in objective reality, to intervene before great damage is done. To some extent, this is what happened during the thousand point crash.
If the markets were merely a superior Las Vegas, a really fun gambling game, it wouldn't matter t anyone but the players. But the markets serve critically useful functions in our economy: they raise capital for business ventures, allow that capital to be reallocated according to the demands and desires of the economy and the people who participate in it, and provide a window into the activities and health of the corporations that make up an important part of that economy. The price and volatility distortions introduced by high velocity algorithmic trading threaten these useful functions.
It would be impossible to eliminate the use of pricing models from market trading, nor would it be desirable. But the combination of these models and computerized execution can be controlled. The first step is to slow down the robots, introducing a lag requirement between trades from the same entity. The second would be to introduce into the securities market the limit up or down concept long in use in the commodities markets, where trading is halted in a contract that moves outside of a predefined price interval during a single day. The “circuit breaker” concept adopted in the wake of the 1,000 point debacle is a timid move in the right direction, but totally inadequate to the task. In addition to trading pauses generated by large moves in stock indexes, limits should be applied to individual stocks. Additional restrictions need to be made on off-exchange trades and linkages established to capture the true picture of stocks and indexes traded on multiple exchanges.
When your heartbeat races uncontrollably, medications and a pacemaker are prescribed. The same should be true of the heartbeat of our economy.
New York Stringer is published by NYStringer.com. For all communications, contact David Katz, Editor and Publisher, at david@nystringer.com