
Trading Shares in Milliseconds - raju
http://www.technologyreview.com/computing/24167/
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ig1
All the major equity exchanges have a signal on their feed which indicates
"all stop" to automated engines. It's a signal which automatic trading systems
are required to listen to and on receipt suspend trading. Historically it's
activated by the exchange if volatility has gone too high or if the market is
behaving abnormally. It's one of the many safety systems the financial system
has in place to protect against an algorithmic meltdown.

Meltdown being the apt term, as the safety precautions aren't dissimilar to
what you have in a nuclear system. You have multiple levels of checks-and-
balances. For something to go seriously wrong 11-12 things have to break in
combination. Obviously this isn't impossible and can (and probably will)
happen sooner or later, but it in everyone's individual interest as well as
the collective interest to prevent a collapse.

The big problem isn't the risk that an investment firm will screw up and do
bad deals (in practice bad share deals due to system error tend to be reversed
by mutual agreement by the counterparties; banks know systems screw up and
generally are willing to reverse such deals), but rather some new form of
systematic risk is created which isn't properly protected against. Dealing
with systematic risk is precisely where the regulators should be coming in
because it's outside the capability of any individual institution to deal with
it.

~~~
anamax
> Dealing with systematic risk is precisely where the regulators should be
> coming in because it's outside the capability of any individual institution
> to deal with it.

Actually, regulators are quite good at creating systemic risk.

The widespread ownership of Fannie and Freddie stock by banks, which killed
their balance sheets when Fannie and Freddie went down, came from regulation.
So did the popularity of securitized mortgages and "insurance". (Regulators
required insurance, AIG's fit the bill, and everything was great, until it
wasn.t)

And, let's not forget that Wells Fargo got hammered because it didn't go along
with the regulators' "requests" to do dumb home loans.

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Tichy
Could the problem possibly be solved in a different way, for example a
different kind of market or with different transactions (or by publishing
information differently)? I have a feeling that the existing stock exchanges
deliberately leave the system as it is, because they earn money from the high
frequency traders.

As an example for what I mean: if there was only one stock exchange, there
would be no arbitrage between different stock exchanges. Or maybe transactions
could come with a delay. Or buyers and sellers could be more open about their
prices. Essentially, what would the market look like if the high frequency
traders were 100% efficient - couldn't it be constructed to be like that
without the high frequency trader's involvement?

The one example where the high frequency traders can determine the exact price
by ordering and canceling within milliseconds certainly does not sound very
fair.

~~~
ig1
There are lots of stock exchanges which offer alternative algorithms for
order-matching. It's up to each individual company which primary exchange it
chooses to be listed on (although obviously it can't stop interested parties
creating a secondary exchange using whatever rules they want between them).

Some exchanges specifically prohibit the practice of flashing while others
don't. It's a free-market, if people and companies want to trade on exchanges
with alternative matching algorithms and prohibitions on flashing, there's
nothing stopping them from doing it.

Exchanges are only as valuable as the people who trade on them, if the traders
want another set of rules than the exchanges have to adapt otherwise the
traders will go elsewhere.

~~~
Tichy
Sure - so I guess if the hf traders really were a problem, people would start
migrating to other platforms.

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socratees
The conclusion of the article: Automated Trading could be dangerous to the
market as such and should be closely monitored. They appear disturbingly
similar to the hedge funds of the old days. Besides, quant-finance big shots
like consider automated trading based on algorithms risky.

Correct me if I'm wrong.

~~~
imajes
Actually, I think this argument (posed by the journalist) was woolly. Given
that the high speed trading firms seem to stay market neutral (each trade is
adequately hedged) and unwind their trades within hours or days, their
inherent risk is less than that of massive pension funds withdrawing their
capital as we saw in the 07/08 crash.

As was said in the article, these guys are really just providing liquidity for
smaller traders (i.e. you and me) who want to be able to move on a security in
small chunks without having to pay for an expensive broker.

That said, there is a crash-scenario if the traditional (i.e. non high-speed)
platforms are triggered via stop loss mechanisms to offload lots of stock
fast. But again, this shouldn't happen if they do two things:

First: look at the source of the trade. If it's one of the high speed firms,
they should just ignore the trade unless it moves with a velocity of say 25%
more than the high speed stuff - i.e. if it's dropping by 1.25% of the price
per minute rather than 1%, then it should consider selling. (or, for a more
general formula - sell if total_velocity - highspeed_velocity = x/s)

Secondly, take wider market movements into consideration - if the entire
sector is falling, it's probably not an issue with the security, so there's
really no point in getting out at that point - it should recover.*

The one technique revealed in that article which i found interesting - pinging
to find the edges of the applicable range trade- guessing the probable worst
case purchase by offering and withdrawing stock to see if it's jumped on. I
could imagine this getting banned, along with the 'who's trading soon'
information.

* of course, this depends on the time period the stock is willing to be held for - if the goal is day trading, then you're not going to want to stick around.

~~~
bd_at_rivenhill
I work in this area, and the market risk you allude to here is not the one
that scares me. The scary one is what I like to call algorithm or system risk.
The 2003 Corinthian Colleges incident mentioned on page 3 of the article is a
good example, but I've seen much worse. I once saw a major bank take literally
a billion dollars of risk on in approximately 10 seconds due a bug in their
algorithm (most likely a new release of a modified program) that interacted
with a poorly implemented exchange interface. Some of their counterparties let
them out of the trades and some didn't. Releasing new software can be a hair
raising experience due to the poor quality of testing systems provided by the
exchanges, the speed at which money losing trades can happen, and the vast
complexity of the environment faced by the software.

~~~
imajes
I wonder how long / how hard it'd take to implement a shadow exchange to test
new algos and systems... Like, perhaps new code needs to be certified in a
full test environment before being deployed to the live market?

Seems like something along those lines would adequately deal with the
uncertainty risk here.

~~~
sophacles
I think one of the problems comes from the fact that big players affect the
game. So if say, Citi launches a new algorithm that does some new crazy thing,
which turns out to trigger random issues or unexpected responses in other
algorithms -- such a thing could make lots of people other than citi a pile of
money. Are those people really going to want Citi to test it too well?

Another, real concern with such a shadow market, where say everyone is running
their algorithms (to prevent the above scenario), is that i could test "a
buggy version" and find holes and odd behaviors of my competetors for free,
since it is all play money.

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udfalkso
[http://www.businessinsider.com/high-frequency-trading-
hits-t...](http://www.businessinsider.com/high-frequency-trading-hits-the-
daily-show-2009-10)

The Daily Show does an amazing job with this subject.

~~~
clistctrl
How did they do an amazing job at all? The linked video (picture #7 is a
video) was far more productive.

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reader5000
I always wonder what general sort of "algorithms" they use. Neural nets?

~~~
BrentRitterbeck
This is what most of my research has been. Here's a post from Markenomics that
I created some time ago with a lot of links on the algorithms used.

<http://www.markenomics.com/item?id=321>

Also, the US Patent website has lots of interesting stuff if you are really
wanting to dig deep into this stuff.

~~~
redherring
That site has tons of information. I wonder how come I've never heard of it.
Thanks a ton.

