The financial market has been taken over almost completely by robots, who use high frequency trading to make stock market decisions.
Humans might be smart, but robots are smarter – and more importantly, faster. Robot traders, according to BBC, are computers that make their own decisions about what and when to buy and sell at about 1000 times faster a rate than any human.
- Robot trades are amazingly fast, measured in milliseconds, microseconds – even nanoseconds
- A speedy robot can “front run” slower traders, snap up assets, then resell them to the slower trader
Basically, the image of nervous brokers of Wall Street you might have planted in your brain, sweating, calculating, and making phone calls, is about 30 years outdated. They have been replaced by electronic boxes that use algorithms to decide trades in milliseconds or less.
- Millisecond: 1 thousandth of a second
- Microsecond: 1 millionth of a second
- Nano second: 1 billionth of a second
How does High Frequency Trading (HFT) work?
As defined by Anthony Brockwell with Carnegie Mellon University’s Department of Statistics, algorithmic trading is the act of making trades in a market, based purely on instructions generated by quantitative algorithms.
- HFT algorithms are programmed by humans who build in detailed instructions about how to trade
- The algorithms are top-secret and closely guarded by those that develop them
As opposed to personal trading, trading based on algorithms eliminates decisions being made off of personal beliefs, gut-feeling predictions, or compulsive desires to gamble. These very human traits can be risky when dealing with large amounts of money.
When, rather than relying on human instincts, traders rely on algorithms (programmed instructions based on current and historical price records) the market has more liquidity due to high-frequency trading, intelligent technology, and lowered commissions.
What is the downside?
According to the Atlantic, the downside of high frequency trading is that it can hide the identity of large buyers and sellers to stop spectators from getting in front of the trades. At such high speeds, the risk of flash-crashes also increases, as occurred in 2010 in New York City.
According to a testimony by Commissioner Bart Chilton as recorded by the US Commodity Futures Trading Commission, high frequency trading also poses issues of regulation: “even if we get a better handle on how to regulate this breakneck speed trading, the methods, the machines and the markets will continue to change,” he notes, and “we shouldn’t have a system where you have to fight through all the computerized noise for fair access to the markets.”
In 2016 the Securities and Exchange Commission (SEC) proposed new rules that would require algorithm developers involved with HFT trades to register with the SEC as securities traders.
Robots on the rise
Since they are so fast, critics argue (.pdf) that robot algorithms can distort markets and create unfair advantage for the most advanced robot traders. In response, a startup called IEX developed a new, fairer stock exchange that was approved by the SEC in 2016. The new IEX exchange:
- Regulates the speed at which trades are made, so everyone gets a 350 millisecond “bump” – a brief delay that that evens the playing field for all traders
- Makes market data more transparent and more available than other exchanges
In many ways the IEX exchange is a grand experiment to test the market demand for throttling unruly trader bots. As algorithms get faster, only time will tell if HFT robots can be tamed.
Updated. Cover photo by D J Shin and CC commons, modified by Curiousmatic.