Machines trade anywhere from 25 percent (Australia) to 70 percent (U.S.) of the volume on stock exchanges. The opportunity to make money depends on the speed of your trading systems along with the intelligence of your algos. Algorithmic innovation is critical for high frequency trading firms to find an edge.
Research by AITE Group suggests that the average lifespan of a trading algorithm can be as short as three months. With such a small window of opportunity, trading firms must design, test and deploy new algos on an almost continual basis. No wonder there are problems.
When we allow machines to make the decisions for us, it is imperative that we design them to be fail-proof. Testing in a non-production environment should be mandatory and back-testing should be exhaustive. Poor quality due diligence and quality assurance is producing catastrophic consequences. It is our responsibility to ensure that our machines, or robots if you will, do no harm.
I am reminded of author Isaac Asimov's first law of robotics: “A robot may not injure a human being or, through inaction, allow a human being to come to harm.” The ‘harm’ in Rule No. 1 is happening to the marketplace. The flash crash wiped a trillion dollars off of U.S.-listed firms’ market capitalization. Knight Capital’s rogue algo wiped $440 million off its balance sheet and forced it to look for backers in order to survive.
If algorithms and trading systems were programmed with Asimov-style parameters, there would be far fewer glitches. But even if you are the most conscientious firm out there, you cannot ensure that your counterparties have also programmed and tested their systems and algos thoroughly. And it remains your responsibility, to your customers, staff and shareholders, to ensure that those counterparties do not do any harm to your bottom line or reputation.
Catastrophe can only be avoided by adding an extra layer of control in the trading process; a layer that monitors counterparties for rogue algos or fat-fingered trades. That way you have both belts and braces – control over internal trading systems and awareness of external ones.
Yes, there will be a tiny bit more latency. But isn’t a small latency hop better than bankruptcy?
High-Speed Data and OTC Markets (
Comments | Post a Comment
13 Comments to "Bringing Order to Machine-Led Chaos":
crammond1964
13 August 2012
The regulators have to enforce safe and proper markets , knights disaster proved we have learnt nothing from May 6th crash in 2010 . The guilt is equally shared by the exchanges who returned their market making status a week after almost bringing market to its knees ! You could not make this up ; we desperately need confidence back in the marketplace and because algos and HFT have total exchange backing we have to put up with a constant growing manipulative markets . Sadly to protect the exchanges profits they have now decided to enter "dark pool " arena , market abuse will thrive here !
Comments (252)
Anonymous
13 August 2012
Regulations meant to monitor the market from rogue algos, well intentioned though they may be, will do nothing but bring a false sense of security to the marketplace. The complexities of software coupled with market competition leave most firms in a tenuous position when it comes to stress testing algorithms. This focus on 'protecting' the market through testing is completely misplaced.
shamlet76
13 August 2012
http://www.thestreet.com/story/11661639/1/flash-crashers-ready-to-feast-on-corn-street-whispers.html?puc=yahoo&cm_ven=YAHOO
those trades are only "bad" to the algorithm owner. they should quit cancelling trades. if the software is not for prime time, it should not be running. investors are going to get stung by flash traders OR lose their profit by the "give me your $" machines. if the algorithm takes your $, that's ok. but we don't want the algorithm owners to lose $. there are other sides of these "erroneous" trades. it's happening in derivatives, which affect underlying assets. the SEC needs to take action ON BEHALF of investors. this is a daily occurrence. there are counterparties to these trades. i have never before heard of a "do over" in stock trading, and, worse, only the thieves get the "do over". what a market! makes me want to trade (NOT).
http://www.nanex.net/FlashCrash/OngoingResearch.html
Comments (149)
cmackie
13 August 2012
Testing in a non-production environment and exhaustive back-testing wouldn't have made a difference in the Knight case. Check out this piece from Nanex, which strongly indicates that a piece of code from the test environment was the cause of Knight's issues: http://www.nanex.net/aqck2/3525.html
Comments (26)
shamlet76
13 August 2012
who is going to this? just the perpetrators? who is representing investors? http://sec.gov/news/press/2012/2012-153.htm
Washington, D.C., Aug. 8, 2012 — The Securities and Exchange Commission today announced that it will host a technology roundtable next month to discuss ways to promote stability in markets that rely on highly automated systems.
The roundtable entitled “Technology and Trading: Promoting Stability in Today’s Markets” will take place on September 14 and convene experts on designing, operating, and controlling the systems that form the core of our market’s infrastructure.
Comments (149)
shamlet76
13 August 2012
i disagree with the conclusion that we can build in less harm through a tiny bit of latency. we, speaking as an investor, don't NEED HFT at all. we did perfectly fine without them. these HFT systems are "gaming the system". they want to fight with each other for investors' $. this is a video game idea. programmers go from one owner to another, bringing the weaknesses/secrets from their past systems with them.
they are not marketmakers. they are extraneous to the market. they take $ out of the stock market, are a capital outflow. they create instability.
what we should do is not allow exchanges to pay rebates. we should not allow them any advantages such as advance information or special information.
Comments (149)
vddobre
25 August 2012
I say we don't need automatic trading at all, high frequency or not. Automatic, ie algorithm-generated trading, is by definition distorting the markets, and bears little if any economic significance. It highlights the corruption of technology use to break contact with real life economy. It turns trading into a giant video game where millions and billions of dollars are virtualized to mean little more than strings of numbers on a screen.
Comments (24)
cmackie
27 August 2012
shaemlet76 and vddobre: An examination of the history shows that technology is the primary root of ALL human progress and it is no different with automated electronic trading. You may not like the effects of that technology, just as buggy whip makers complained about the advent of the automobile, but that doesn't change the fact that these tecnnological changes are here to stay. Comments such as "gaming the system", "create instability", "distorting the markets", and "bears little if any economic significance" have no foundation in fact and do not further the conversation. There is no denying that there are issues that must be dealt with (I wholeheartedly agree with shamelet76 of exchange rebates: these truly can distort markets) but, by and large, I believe that automatic electronic trading is a good thing for nearly all concerned.
Comments (26)
shamlet76
27 August 2012
i disagree. http://www.nanex.net/flashcrash/OngoingResearch.html
Comments (149)
vddobre
27 August 2012
Cars could go much faster than they do now, yet we do set speed limits in the law, tomorrow directly in the engine; nuclear energy could soon be totally abandoned.
Comments (24)
cmackie
27 August 2012
Cars will go much faster AND be much safer in the future with the addition of technology. As for nuclear energy, that may well be a Pandora's Box that we wished we had never opened.
I have no argument that technology should be managed but I do wholeheartedly disagree with statements about automated trading like "gaming the system", "create instability", "distorting the markets", and "bears little if any economic significance". These statements are simply not true.
Comments (26)
crammond1964
27 August 2012
sadly our regulation has yet to catch up with the rapid increase in speed ; until this equation is balanced we will find manipulation and abuse increase .
I would drive on Motorway at 180 mph if i knew I would never be caught !
Comments (252)
vddobre
27 August 2012
http://seekingalpha.com/article/789521-the-new-stock-market-obscenely-volatile-perfectly-inefficient-and-it-only-gets-worse
Markets that are dominated by algorithms chasing and fighting with each other have nothing of their original reason to be: help finance the real economy - indeed they have no meaning left to them at all, and no use - except for the little programming "genius" behind.
Comments (24)