Trading in the Era of High-Speed Algorithms (Part I)

Automated Trading 
http://davidbrin.wordpress.com/2011/12/10/gingrich-asimov-and-the-computer-trading-monster/

In the previous post, I gave the example of scientists and statisticians looking at “Big Data” from Twitter to predict trading and investment opportunities. Well, this convergance between tech and finance is not new and can be manifested in different forms. To continue our discussion on the impact of ICT on financial services, let us look at algorithmic trading (algo trading). In this day and age of Hi-Tech it has never been easier to trade securities. Note that I haven't I said that trading has become more efficient or safer, simply, it has become easier and, probably, cost-effective. With algo trading, an investor can specify her trading preferences and punch then into a trading platform (check photo). 

            My own trading page with NCB Capital

Down to the nitty gritty details, traders can add and modify their orders (trades) according to their needs and risk tolerance, including execution date and time, buy/sell price, quantity, price range, etc. This might sound commonsensical for you, but what if you have to place, trade, and monitor hundred of thousands of deals a day! Try to imagine how it would be like if you were a stock or currency trader getting orders willy nilly, to the extent that you are unable to organize your order books, let alone concentrate on your main task, that is trading.

Let us look at high-frequency trading (HFT) which is said to comprise the majority of equity and futures tradings. In 2009, HFT firms accounted for only 2% of all of the trading firms in the U.S but they dominated the equity market with 73% of the total trading volume. HFT is the result of a proprietary computer programming that enables firms to trade large-volume of equity (as well as a myriad of other securities) in a blink of an eye, literrally. High-speed trading is the name of the game and it is reported that about 19,000 deals can be performed in 1 second. Although people are still involved in the input/output of the decision making process, the impact of ICT (i.e automated trading) has changed the whole trading ecosystem. Thanks to the automated nature of trading, common investors as well as savvy hedge fund investors nowadays would rather speculate rather than invest long term. The trading behavior is shifting and the tech-finance convergence I mentioned earlier is fully manifested. As Yan Ohayon in one of the TED Talks said (check the attached YouTube video) "The average holding time period at Wall street has shrunk to a mere 22 seconds". 

TED Talks: Algorithmic Trading and its Impact on Markets

With HFT, latency has been reduced greatly while computational power is rapidly increasing. Two obvious advantages of HFT passed to small investors are (1) added liquidity to the markets and (2) reduced trading costs. Another important aspect of trading algorithms, such as HFT, is their impact on how investors choose which stocks to buy and how to value firms. Hedge fund managers, CEOs, analysts, as well as main street investors started relying on computers to determine the "price" of a firm's stock. Finding the true value of a security has become relatively easy given the power of computational machines,  yet it is way more complex than that. Because automated platforms can run all sorts of trading averages, closing/opening prices, and financial ratios yet, as we all know, that market prices are subject to much more than the fundamental and technical analyses.

Automated trading has had a great impact on opening up the financial markets to small investors. Nowadays, basically anyone with a bank account can trade currencies (forex) or buy/sell stocks on an over-the-counter market or on a stock exchange, such as NASDAQ. According to the Man vs Machine infographic, the ease of use, anonymity, and reduced market layers, are among the top reasons behind algo trading increasing popularity. 

Man vs Machine Infographic

The future of trading will continue to change with the evolvement of high-speed computational platforms and machines. Which in turn is having a tremendous impact on the role of regulators, banks, financial brokerage houses, insurance companies, indexes, and technology providers. Reduced commission costs, higher traders productivity, low latency, information sharing, execusion consistency and customization are among many impacts information and communication technology (ICT) has had on the financial trading business.  

-FM