

Automated Funds Now Dominate Stock Market - rocketsurgeon
http://online.wsj.com/article/BT-CO-20090618-707189.html

======
euroclydon
"Traditional money managers face the increased likelihood of seeing orders
"gamed," or deliberately gouged. High-frequency funds have myriad strategies,
but many depend on sniffing out "order flow" - or what hedge funds, mutual
funds and pension funds that hold stocks for fundamental reasons are buying
and selling."

In other words, everyone except the insiders get screwed, but the insiders
depend on a steady flow of suckers, er I mean aspiring retirees, to skim money
from.

~~~
byrneseyeview
Actually, it's pretty tough for an algo fund to make money when Aunt Harriet
sells the 100 shares of GE she bought in 1962. The big, dumb mutual funds that
turn over their portfolios in a year _do_ get hit by this kind of stuff.

On the other hand, algo funds can't make money without 1) making market prices
reflect the intentions of traders, rather than just their most recent actions,
and 2) making the market more liquid. Both of these add a lot of good to the
economy in general, even if they do it at the expense of one class of
investors.

~~~
ggruschow
It's especially hard because Aunt Harriet's order almost certainly won't
actually make it into the open market. Her broker will very likely
"internalize" it (trade against it themselves), or sell it to someone else who
will (e.g. Citadel will happily buy their flow.. they bought Ameritrade's last
I checked).

That very well may be the future of these funds - compete for the customer or
pay for order flow like in US Equity Options rather than compete in the open
markets. All the orders that can be traded against with any of the typical
profitable strategies (most strategies at these places are fairly well known
and similar).. won't even make it to the real market. Doing it this way avoids
the risks in the open market, notably adverse selection and the need to over-
represent your interest in multiple places to increase your execution quality.

~~~
anigbrowl
Good point. I didn't think of that.

------
ckinnan
_The popularity of these strategies has spawned a cottage industry called "co-
location," or "proximity hosting." Exchanges sell the funds "rack space" in
the data centers where their servers process trades to gain an extra couple of
milliseconds on the competition._

The ultimate in optimization.

~~~
ggruschow
Serious discussion of hosting your software on their servers started a couple
years ago. I don't think anyone's done it yet, but people have at least built
the technology out.

Of course, it's really stupid. Nobody that actually wants to own the stock or
sell an investment cares about the difference of 50us. The competition at that
level is at best inane. At worst, it makes it worse because it discourages
people from trading real size and floods the world with all the little nearly
meaningless quote updates.

------
byrneseyeview
There is a problem with this article: it's equating an algorithmic trade with
an informed trade, and assuming that if most trades are algorithmic, most
market moves are due to algorithms and not individual traders.

But those algorithms are basically looking for what future trades will be,
based on current trades. For example, if someone invests $1 million, in
$100,000 increments, they'll try to predict that $1 million investment. But
the $100,000 increments are not the information the market ought to react to
-- the final investment is (the trader, in this case, is not $100K more
optimistic about the company during each increment; she's $1000K more
optimistic, but is acting on this optimism in a more measured way).

Algo trading funds are betting on secondhand opinions. They aren't creating
their own. The directional effects of this algo trading should be very hard to
detect -- after all, if you can make a sensible prediction about what the
market is going to do, you should probably be working for a hedge fund rather
than writing (or commenting on) the _Journal_.

~~~
anigbrowl
Indeed; given that a basic function of the stock market is price discovery,
surely automated trading causes a steepening and undesirable drop in the
signal-noise ratio, amplifying signals past the point of distortion?

From my signal-processing experience, it reminds me unpleasantly of the
Douglas Adams skit about the guy who gets rich by finding a way to convert
stock prices to music so people can understand them without thinking. With
audio, complex realtime input can result in all kinds of nonlinear
distortions. This can be fun if you like crunchy sounds, but it can also
spiral out of control. A lot of stock chartists (who believe in price
movements rather than fundamentals as a guide to strategy) remind me of
astrologers or numerologists: there's some math involved, but also a lot of
mystical belief in golden ratios, fibonacci numbers etc, without any real
scientific methodology behind it.

I have a hunch that a strategy of making small trades with a clearly embedded
but arbitrary signal will expose a weakness in these systems for incorrectly
targeting local maxima - eg if you start making meaningless trades in penny
stocks where the volume Vn = Vn-1 +/- Phi, or whatever - sooner or later your
arbitrary but very very consistent signal will be read as a 'strategy' and
amplified by a robot.

~~~
byrneseyeview
_I have a hunch that a strategy of making small trades with a clearly embedded
but arbitrary signal will expose a weakness in these systems for incorrectly
targeting local maxima - eg if you start making meaningless trades in penny
stocks where the volume Vn = Vn-1 +/- Phi, or whatever - sooner or later your
arbitrary but very very consistent signal will be read as a 'strategy' and
amplified by a robot._

You'd need to do a bit better: you would have to set up a situation where your
strategy triggers algorithm A, which triggers B, which at some point leads to
A being triggered again. You might do something like have one options
strategy, and one equity strategy, and then do equity and options trades in
the same company.

~~~
anigbrowl
Subject to the observation above that many brokers would probably just
reconcile your trades with those of other customers before sending the final
totals to the exchange, thus destroying your strategy, you're quite right by
but you might well be able to experiment with relatively small sums on
relatively worthless stocks.

------
htsh
Is there a way to read this article without subscribing? It sounds fascinating
and I would love to read it. I'd even pay to read the individual article, but
that doesn't appear to be an option.

~~~
anigbrowl
Load and hit f5/click refresh to read anything you want at the WSJ site :)

~~~
htsh
still doesn't work for me. I get the first paragraph and that's it.

~~~
wheels
Standard WSJ workaround -- click on the first link:

[http://www.google.com/search?q=Automated+Funds+Now+Dominate+...](http://www.google.com/search?q=Automated+Funds+Now+Dominate+Stock+Market)

I think we discovered a while back the the logged in / not logged in
discrepancy is that the WSJ doesn't seem to prompt people to pay that are
outside of the US.

~~~
anigbrowl
I'm in the US, and I don't have any proxies or so. Maybe they just think I'm
cool because I'm using Chrome. And of course, they'd be right.

------
anamax
There's something odd going on here.

Automated trading has dominated the stock market for at least 10 years. (LTC
was a melt-down because auto-traders respond very quickly.)

So, if something is actually different now, it's in the word "funds". They're
not talking about mutual funds, so what are they talking about that's actually
new? (Hmm - I wonder which mutual funds are automated and how much.)

------
mhb
Black Box - Development of Market Prediction Software:
<http://www.thomasbass.com/black_box_1356.htm>

------
stuffthatmatter
alternate headline: you lowly investor vs Goldman Sachs

