Quantifiable Insanity

I felt compelled to write this short piece following the most recent high frequency trading debacle at Knight Capital Group where $440 million flowed down the proverbial drain in less than one hour. I don’t think that automated trading should be banned outright but the volume of trades and the frequency at which stocks are now automatically traded is ridiculous. It seems to me that the diffentiating factor should be the acuity of the traders judgement, not whether you can get your orders in a few milliseconds faster than the next guy.

Consider the following statement:

“I believe in this company and its ability to generate profit and want to invest in it.”

Now try to apply this kind of sentiment to trades performed on a millisecond basis by hordes of autonomous agents. Agents programmed in advance with strategies for eeking out tiny profits from miniscule fluctuations in the markets, fluctuations they themselves stimulate. I would question your rationality if you came to the conclusion that this makes sense.

In a recent Wired article the weird and wonderful world of high frequency and low latency trading is covered in some detail. Even though the article is a bit sensationalist it still highlights the extremes to which these companies will go to get an edge.

In one of the more extreme examples we are told of quants seizing on the story of neutrinos possibly traveling faster than the speed of light. An experiment was being conducted as part of the OPERA experiment which is a collaboration between Cern in Switzerland and the Gran Sasso National Laboratory in Italy. The only problem was the neutrinos sent from Cern were picked up at Gran Sasso an average of 60 nanoseconds too early. After seemingly exhausting all sources of possible error the researchers reached out to the scientific community for help validating or refuting their findings. Few in the scientific establishment believed that the results would hold up, while it is at least implied in the article that some enterprising quants ran the numbers to find out just how much of an edge this would give them if true.

Even though the above example may seem far out, the underlying motivations are very real. Plans exist for laying down dedicated fiber-optic cables straight between trading sites and exchanges (instead of meandering through towns and cities) as well as plans for laying down more optimally routed cables on the ocean floor for faster transcontinental connections (to name but a few). All this proposed investment for what?

The stock markets exist for a reason, to allow companies to raise capital. It puts money that would otherwise sit idle to good use and in so doing promotes economic growth. It keeps people employed and as money invested trickle down to individual employees it will eventually flow back into the wider economy. What part does high frequency trading play in this grand cycle?

It would seem to be time to seriously reevaluate why we invest and trade. We need to return to basics or at the very least take a significant step in that direction.

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