Between the debt crisis in Greece and the hanging fate of the Euro, the sub-prime crisis has somewhat been forgotten and the Gordon Gekkos of the world are back to doing what they do best. Devising new ways to beat the market & picking up those million dollar bonuses!
We all know that the sub-prime crisis was caused by those mortgage derivatives or whatever they were. We don't fully understand it of course, most normal people don't, which is why the whole fiasco happened in the first place! But basically it was a bunch of finance whiz kids, selling high risk financial instruments to laymen like you and me, who had absolutely no clue what the frigging hell they were getting into. And when they realized they were going to default on their loans anyway, they thought "Why keep paying premiums?". I'll just default on the loan right now, save myself some premiums, and let the bank take away the land. And that's just what everyone did. And all those high flying banks were left with absolutely no money and lots & lots of worthless homes!
Now the sub-prime crisis was bad enough right? But of course greed knows no bounds, and we now have a new buzz word in finance - HFT or High Frequency Trading. Technology has made it possible today, for transactions to be executed literally in a matter of a few microseconds. No kidding! There are actually dedicated HFT firms which regularly trade up to 100 million shares daily. The margins are very small, fractional even, but the volumes ensure them the profits they seek. And because of the high speeds, the entire decision making process has been completely outsourced to highly complex computer codes. These codes, are programmed to seek out certain inefficiencies, and thrive on them by jumping in and out of stocks on different exchanges within microseconds. Arbitrage 2.0!
Already, according to an article in Newsweek, over 70% of the U.S. equity volume is computer driven. I don't know about you, but to me that seems really scary. Gone are the days, when fundamental strategies like seeking out the well performing companies were applied. Today it's all about hiring the best programmer & best financial whiz to collaborate and come up with those algorithms that can seek out market inefficiencies and act upon them in real time and rake in the dollars.
Shares are supposed to represent the worth of the company. I concede that basic derivative instruments like future and options allow people to hedge against risks, and also aid in price discovery and help "complete" the market, but HFT for me is the limit. The sheer thought that millions of peoples' life savings and investments are at the mercy of computers makes me sick. And the most controversial aspect of HFT is that even during crashing markets, they can make immense returns due to market volatility.
It's difficult for me to say whether my loathing for these "glorified gamblers" stems from envy or reasoning. I'm certainly not knowledgeable enough to know what the inherent risks of HFT are but all I know is that computer programs across the globe automatically buying and selling billions of shares everyday has to be risky.
What do you think?
We all know that the sub-prime crisis was caused by those mortgage derivatives or whatever they were. We don't fully understand it of course, most normal people don't, which is why the whole fiasco happened in the first place! But basically it was a bunch of finance whiz kids, selling high risk financial instruments to laymen like you and me, who had absolutely no clue what the frigging hell they were getting into. And when they realized they were going to default on their loans anyway, they thought "Why keep paying premiums?". I'll just default on the loan right now, save myself some premiums, and let the bank take away the land. And that's just what everyone did. And all those high flying banks were left with absolutely no money and lots & lots of worthless homes!
Now the sub-prime crisis was bad enough right? But of course greed knows no bounds, and we now have a new buzz word in finance - HFT or High Frequency Trading. Technology has made it possible today, for transactions to be executed literally in a matter of a few microseconds. No kidding! There are actually dedicated HFT firms which regularly trade up to 100 million shares daily. The margins are very small, fractional even, but the volumes ensure them the profits they seek. And because of the high speeds, the entire decision making process has been completely outsourced to highly complex computer codes. These codes, are programmed to seek out certain inefficiencies, and thrive on them by jumping in and out of stocks on different exchanges within microseconds. Arbitrage 2.0!
Already, according to an article in Newsweek, over 70% of the U.S. equity volume is computer driven. I don't know about you, but to me that seems really scary. Gone are the days, when fundamental strategies like seeking out the well performing companies were applied. Today it's all about hiring the best programmer & best financial whiz to collaborate and come up with those algorithms that can seek out market inefficiencies and act upon them in real time and rake in the dollars.
Shares are supposed to represent the worth of the company. I concede that basic derivative instruments like future and options allow people to hedge against risks, and also aid in price discovery and help "complete" the market, but HFT for me is the limit. The sheer thought that millions of peoples' life savings and investments are at the mercy of computers makes me sick. And the most controversial aspect of HFT is that even during crashing markets, they can make immense returns due to market volatility.
It's difficult for me to say whether my loathing for these "glorified gamblers" stems from envy or reasoning. I'm certainly not knowledgeable enough to know what the inherent risks of HFT are but all I know is that computer programs across the globe automatically buying and selling billions of shares everyday has to be risky.
What do you think?
Now that you've written brilliantly about HFT, I am thinking about how people respond to the question: "So what did you do at work today?"
ReplyDeleteThe answers may vary from "I cleaned the floor today and made world a cleaner place" to " I engineered something to help someone somewhere". I wonder how the financial gnomes will respond? Would it be: "I manipulated people's emotions and changes in the system to earn myself some bucks without adding any value to the system.."
If I'm wrong, can someone please tell us why there is such a stark difference between the market (speculation) and the real economy??
Just came across your blog Anuj. Nice report on HFT, read about it back then. As for the fear about HFT, I don't think it's required right? For instance, any investor/trader investing in the market has to primarily identify his strategy, whether he wants to invest(fundamental analysis) or trade(technical analysis). All computer based algorithms deal with technical analysis, so if a person opts for trading HFT is highly beneficial to him. If for investing, HFT is no good. So, in effect, at the time of signing up with a brokerage company, all the person has to do is identify his preference and the company's technology. Besides, HFT was a very costly affair when it was launched(don't know the current situation), mostly the elite used it. That still makes up for a huge chunk of the traded volumes, I agree.
ReplyDeleteBesides, the need for HFT was well placed too. It does help in reducing market manipulations by operators or accidentally placed trades.
As for stark difference between market and economy, this is bound to happen and will forever happen. One thing to note about the market is it isn't a good indicator of the economy, it is only a good indicator of the people's sentiments. If sentiments are good/bullish, market goes up. Besides, stock price of a company is always forward estimated based on earnings or on news or technical data, never on the current condition of the company.