Are the robots taking over the market?
You hear a lot these days about how robots are taking over the world…
From cars that drive themselves to robots serving you drinks in a bar…
Some are saying that artificial intelligence could eventually become sentient and be able to take over the world…
Sounds like they’ve been watching too many Terminator films, if you ask me.
In trading we hear about automated trading, and in particular, high frequency trading.
A recent article from Greenwich Associates said that in 2014, 11% of all institutional order flow in the FX markets originated from non-human sources (read: algorithms).
The direction is obviously up for algorithms – they make less mistakes than humans and can work a lot faster.
But I think it’s almost a race to the bottom…
These algorithms are going to end up competing on such small timeframes that the lower bound time of 0 will eventually become unreachable, by which time another form of disruption will have been invented.
One issue here is that algorithms are essentially very small timeframe scalpers.
They might take a quarter of a tick per trade, but do this 3-4 times per second.
If you’re doing that all day every day, you can see the amount of profit they make.
However, they are essentially market making – that is, providing inventory to the market to keep it liquid.
Well this is what they are meant to be doing…
This is actually toxic liquidity. There’s a high level document that you can read here that explains this – but essentially they are providing risks to the market that can cause flash crashes, since they end up doing the same thing.
That can be seen by the rise of the fast falls and rebounds in price that we have seen in the past 5-6 years.
Just last week we had one in gold futures, when ‘someone’ dumped $4bn worth of gold contracts on the market.
No human is stupid enough to do that (well…).
If you have ever read the book Flash Boys by Michael Lewis (thoroughly recommended), you’d have come across the issue of algorithms.
What many massive firms (ahem… Citadel) have been able to do is find arbitrage opportunities as simple as finding a shorter cable to be able to ‘front run’ (get ahead of the order queue) and drive the price up before selling on minute timeframes.
This bred the IEX which totally prevents this from occurring. This makes the market more transparent of course… and just recently they received regulatory approval to list stocks.
Whether firms will list is another story, but I do like this move to transparency.
What does this move mean for you as a retail trader?
Not so much, as 90% of the time you’ll be competing with the same retail order flow and your broker, however I feel it pertinent to tell you about how the institutional side is moving.
I was having a chat with a top broker who had worked at every large broker and bank you can probably name and he said the market is totally different even from 10 years ago…
The flow isn’t the same, and dealing with poor flow is a broker’s worst nightmare, because you can’t even go to the market to ask what’s happening – it’s all computer based.
It’s a real struggle, when you can only make £500k vs your normal £1m, isn’t it…