shouldnt we traders be worried about algorithmic trading taking over?

[leovirgo]

‘Secretive’ firms dominate US share trading
By Jeremy Grant in London

Published: July 10 2009 17:17 | Last updated: July 10 2009 17:17
FT.com / Markets - ?Secretive? firms dominate US share trading

A tiny minority of a new breed of electronic trading firm is driving almost three quarters of all US equities trading volume and generating $21bn in annual profits doing so, Tabb Group, a consultancy, said on Friday.

The disclosure is one of the first attempts to quantify the impact of so-called “high frequency” trading firms that have quietly grabbed a huge slice of trading in the world’s equity markets.

Some of the trading firms – such as Getco, Peak6, RGM Advisers and Hudson Bay Trading – are far from household names in the markets. Many are based in Chicago and grew out of the city’s options trading pits.

However, they appear to have built up such a significant presence in the markets that they look set to eclipse familiar Wall Street names in their collective influence. Such firms have grown especially quickly as they filled a gap in the markets left by hedge funds.

They typically employ trading strategies that are based not on company earnings prospects and other fundamentals, but on arbitraging minute differences in share prices and trading speeds – known as latency – between exchanges and other trading venues.

Robert Iati, partner at Tabb, said: “They are, as a rule, secretive, stealthy, smart, and relatively unknown.

“The incredible capabilities offered by technology have given meteoric rise to a relatively few high frequency proprietary trading firms that now wield far greater influence on the markets today than most people recognize,” he added.

Tabb estimated that such firms, which include the new breed also known as “electronic liquidity providers”, represent about 2 per cent of the 20,000 or so trading firms operating in the US markets. But they accounted for 73 per cent of all US equity trading volume.

Trading venues have altered their fees structures to attract such firms, which often look for platforms to offer monetary incentives to encourage firms to post liquidity with them in so-called “maker-taker” fee models. The London Stock Exchange this month abandoned a maker-taker fee model introduced only in September last year, a move that its smaller rivals such as BATS Europe are likely to welcome as it could drive more high-frequency traders to them.

The firms included proprietary trading desks for a small number of major investment banks, less than 100 of the most sophisticated hedge funds and hundreds of “the most secretive prop shops, all of which operate with one thing in mind: capture profit opportunities by being smarter and faster than the closest competition”, Tabb said.

Firms engaged in high frequency trading (HFT) use complex computer algorithms to drive their trading strategies, and guard them jealously. The value of such algorithms was exposed this week when US federal prosecutors charged Sergey Aleynikov, a former Goldman Sachs computer programmer, with stealing computer code from the bank’s HFT business

 

[tommog]

I think people are very misguided as to what these "algo's" actually do.

Despite what websites and brokers tell you very little of the market action you see on a daily basis is from people saying "i think eur/usd will go up now because my stochastics are going up a bit and have been "oversold" for 5 bars on my 13.5 min candlestick chart".

The vast majority of these algo's are to make market making more efficient, the only purpose of a market is to provide a liquid environment to allow risk to change hands between buyers and sellers.

There are of course large speculators which take a view on the market but i can assure you (from working in this enviroment for some years now) a lot of these algos work on aspects of the market many of us have no knowledge of. Such as how a U.S based pension fund can effectively hedge an option on an Asian equity market whilst locking in a favourable exchange rate etc etc. Or how a bank can provide a competitive quote on some obscure currency pair and be able to leg into a arbitrage on more liquid pair so they arent holding a naked position. This is what the heaviest traders are doing in the market, not selling the bund because it has formed a head and shoulders on a 5 min chart. There are billions and billions of dollars changed hands everyday by people that really couldnt give a sh*t whether the market is going up or down they are just constantly making a market for a tiny edge 24/7 and the only way to do this effectively is with computers because a human simply cant, fastest finger wins! As Gamma said, this has lead to many positive things, such as discount brokers which have allowed many of us to even attempt to trade.

Day traders/speculators/swing traders whatever you want to call them (and i include myself in this) are at best providing liquidity for the big players and at worst little nusances that get in the way.

People love to say oh head and shoulders dont work anymore, please cite some evidence where they have ever worked? Then people say trend following is dead because everyone knows the turtles system or some other famous breakout system, is that so? Oil going form $70 to $150 then back down again in a almost straight line was a very nice trend thanks.

Even if all computers were banned in trading tomorrow you wouldnt make anymore money than you do now, because trading has always been and always will be hard, because people dont realise everything works sometimes but nothing works all the time and algo's fail just as often as non systemised traders. I can assure you having an algo isnt your ticket to untold wealth, they are continually being wiped out and reborn just like all people involved in this game. So dont worry too much just stay focused on what you do


P.S
This is assuming every person in the markets is basing their decisions on technical factors, amoung the retail community this is the case, but many large investment funds may have 1 or two technical analyst which are regarded as slightly oddball characters and fundamental factors are still the driving force behind decisions. The massive volumes in the markets these days (as opposed to the 60's and 70's) is a good thing, it means that it is less likely that any one stye will dominate.

 

[GammaJammer]

That, quite simply, is one of the best posts I've read on this site in a long long time.

 

[tommog]

glad you approve Gamma, was a bit worried about insulting people with the whole "stochastics on a 13.5min chart" line. But it does frustrate me when i see charlatans peddling these market ideas which most big institutions dont even know about, not because they are such a brilliant idea and undiscovered but because they are so irrelivent to what they actually do.

There are no secrets, there are no insiders and the majority of biggest traders i know dont even know what a candlestick pattern is.

When i worked as a market maker i didnt even look at a chart and that was when i was doing most volume (which by the way was still microscopic compared to a major institution)

 

[pedro01]

Eh...news goes around the globe in seconds....and you think that algo programs can cause market crashes.....soon get caned wouldnt they when theres no fundies to support the position.

Crashes don't happen in 5 mins flat.

It is precisely this that worries me.

When we get complacent about our computer systems and how they have it all figured out with all the necessary circuit breakers etc in place - that's when they tend to run amock.

 

[GammaJammer]

Nothing will ever be foolproof, as long as the world continues to be populated by such ingenious fools.

An old boss of mine said that to me maybe 10 years ago, in response to something someone had screwed up despite the fact that I had been working day and night to make it impossible to mess it up (or so he and I thought).

The exact 'what' it was escapes me - something to do with forward FX risk if I recall. Not really important. I can still hear him saying it to this day. Was very comforting at the time.

 

[Neoripley]

won't this change the markets and their patterns that we have used consistently , wont this make it bad to be a day trader?

Not if you're a trend follower apparently. YOu just go with the flow - doesn't matter who or what is causing it.