Sunday 11 November 2012

Rise of the Machines

 

One of the more interesting stories I came across this week was on Bloomberg http://www.businessweek.com/news/2012-11-06/million-dollar-traders-replaced-with-machines-credit-markets) relaying news that at least one, if not more, of the recently sacked UBS traders in the City have been replaced by Algorithms.

It must be pretty hard being replaced by a computer, however, computerisation for productivity improvements is hardly a new trend, although replacing highly paid workers is increasingly worrying for many of us.

As a sign of the market environment to come, it is instructional though. Already in the US over 60% of NYSE trades are computer driven and in the UK over 40% of FTSE trades are initiated by computers. These numbers are increasing all the time. Now other types of derivatives and non-equity markets are being accessed by computer algorithms with massive allocation of funds to their programmes.

This throws up a few dilemma’s beyond the usual what-the-hell-are-we-all-going-to-do-for-a- living? Firstly, the flash crash in the USA showed that in a panic, the mass of computing power creates an even worse herd-like instinct than humans do, and which is quite a feat! In normal markets algo’s outperform humans as they don’t make emotional and irrational investments and have specific limited risk profiles. You just can’t get a computer Kweku Adeboli, unless through some really bad programming!

On the other side, computers models are all built around statistics and technical analysis. They do not look at analysts’ reports or speak to management. They react to the market moves of the day. So in effect, they are perfect momentum traders, better than you or I every time. But they are rubbish long-term investors by design. They can’t see an AIM stock going up 1000% in a year because they don’t know about the drill/patent/buy-out, unless it is quickly programmed into the code – which is nigh on impossible.

All this should mean in the near future that day-trading becomes a really hard game to win on a TA basis; conversely more fundamental strategies around buy and hold or even shorting over decent time periods, will become more efficient once more. Ignoring short-term volatility, better opportunities will arise and in a more liquid market provided by Algo’s there will be more entry points and exit points for positions – particularly so for smaller retail players than for larger companies who need to take bigger positions.

Equity trading has seen large falls in volume of late with the likes of BGC reporting 20% collapses in volumes. Whilst the algo’s have put off many traders for now who are tired of seeing their trades front-run at lightspeed, this situation may eventually turn around as the benefits of a long-term strategy are seen again. The world of trading and investing is certainly moving fast in 2012.

This post is sponsored by Spreadbetmagazine.com

9 comments:

Bill Quango MP said...

That's all we need!

HSBC is becoming self aware.

Blue Eyes said...

The traditional free-market response to automation is "overall good, individually painful". The economy moves on, more people can spend their time doing fun things than slaving over a hot money desk.

However, you point out the dangers of positive feedback loops.

Just reading a Philip K Dick short story where the entire government is run by a computer which is powerful enough to micro-manage the economy. Gordon Brown's dream and the final answer to the Hayek/Marx debate! Problem is, what happens when once everyone has forgotten how to run their own lives the computer breaks down? Then again, the same question could be asked of our already super-specialised world economy.

(Have you been watching Hunted?)

Graeme said...

Mr Quango...I do not think you want to make that trade (spoken in the voice of HAL)

Electro-Kevin said...

"More people can do fun things rather than slaving over a hot money desk"

Not really. That isn't the reality of unemployment.

Particularly depressing seeing as banker bonuses are often justified because of the 'cascading' of good fortune on the wider economy.

One less banker = two fewer domestic employees (perhaps)

We can't step in the way of progress - my job will go too, eventually. At least I have a second stream of income and an extremely employable wife.

I'm looking forward to lawyering becoming automated.

No Fee - No fee would be great.

Especially as under present standards 50% of them are wrong 100% of the time.

Budgie said...

We are now so dependent on computers in all areas of life that if they go down (hardware, software or electricity supply) then work just stops. This is a fragile state to be in. The Cloud will make that fragility worse.

hovis said...

BE/EK: re the
"overall good, individually painful".
more people can spend their time doing fun things than slaving over a hot money desk.

Yes always a nice idea never works out like this. Did you see the relavively recent ( last 3 - 6months series of articles on FT Alphville about 'a bundance' and how robots woul give us all leisure time. - Utter drivel as hings stand it will be a small group who benefit, the rest will suffer unemployment. Free time is good if you have the resources to live and prosper outside of basic need.

As to Algo ttrading I think the fact that HFT can now trades multiple times in the blink of an eye and there were sme claims that speed has increased, means this is hardly a market in any meaningful sense. It is institutionalised skimming. Problems will arise (and have) given the self referential nature of the algo's. There is too much ego in this, written by disfunctional quants who will not admit their (and their baby's) weaknesses.

As to fragility of society and over reliance on ssomeones dodgy code. I'll just say: EMP

Blue Eyes said...

Hovis/EK

In the 60s and 70s it was a widely-held belief that manufacturing would get so good that huge numbers should "train for leisure". Of course it doesn't work out like that because people like working to earn more than the minimum. If you wanted to live as comfortably (possibly more so in many ways) than a comfortable Victorian you could live in a modern council flat with your standard flat screen telly and all your bills paid for. Not good enough for you? Go and work in Starbucks or a call centre or wherever. The point I was trying to make was that while there might be some industrial pride in digging out coal from a dangerous pit with your bare hands, we've got so efficient that nobody in this country needs to do it. They can lard about watching daytime TV or re-train as a plumber. If you are a bit brighter you could learn to program one of CU's trading monsters! That is my point, innit.

Yes it doesn't spread the wealth out very evenly. That's quite a different issue. We may eventually find a good balance between wealth redistribution and finding ever more inventive ways to keep ourselves lively during the day.

Or are you both really suggesting that the only worthwhile effort is toiling your own strip of land under the watchful eye of the local lord?

Anonymous said...

No doubt the Easter Islanders regarded their behaviour as completely rational too.

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""