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2013-07-08 09:54:39
By Laurence Knight Business reporter, BBC News
"Humans cannot compete on speed, it's as simple as that."
Ten years ago, John Coates was a trader in Wall Street.
Today, he is a neuroscientist at Cambridge University, and spends his days
monitoring traders' hormones to see what makes them tick.
"There are simple tests you can do. When you see a green light... you click a
mouse. The fastest you can do that is 100 to 120 milliseconds. Any basic
cognitive processing, figuring things out, then maybe 200 to 300 milliseconds.
"The trouble is, the boxes - last time I looked - they were processing a trade
in 10 milliseconds, and today I think... we're talking about millionths of a
second."
Those "boxes" are the robot traders - computers that make their own decisions
about when to buy and sell, but a thousand times faster than any human can.
Start Quote
Remco Lenterman
They operate algos that effectively are mimicking what traders used to do
Remco Lenterman Director of trading firm IMC
When you think of a trading floor in London or New York, perhaps you imagine a
gaggle of sweaty men elbowing each other out of the way as they use elaborate
finger movements to convey their frantic orders.
It's an image popularised by the 1980s comedy Trading Places. But it's also 30
years out of date.
For the fact is that financial trading has undergone a computerised revolution
akin to Amazon's takeover of the High Street. All the real action has moved to
cyberspace.
Take the New York Stock Exchange. These days, most trading does not take place
behind its famous neoclassical facade just off Wall Street, but in far less
glamorous New Jersey.
That is where the NYSE has set up a vast electronic trading facility covering
10 acres (four hectares), housing row upon row of computer servers.
And many more acres are occupied by the servers of the robot trading firms
hooked up to it.
Nerdy brainboxes
Computerised trading is an inherently secretive world.
The trading firms keep a tight hold of their trading strategies, people and
computer code (or "algorithms").
Otherwise a rival might figure out their complex-yet-fully-automated trading
patterns, and then copy them, or worse still, dupe their computers into handing
over millions.
Liffe floor traders in 1992 The loadsamoney traders of the 1980s have been
consigned to the dustbin of history
Remco Lenterman, the head of one such firm, IMC in the Netherlands, is trying
to demystify his business.
He says: "In the old days, 10 years ago, a desk of equity traders would have
between 80 and 100 of human traders at an investment bank. Today there's maybe
eight of them left.
"What they do is operate algos that effectively are mimicking what traders used
to do, and they're tweaking constantly these algos and monitoring the risk of
what goes on in the market."
In other words, the iconic high-testosterone Loadsamoney traders of the past -
the "Masters of the Universe" derided by the American author Tom Wolfe in the
Bonfire of the Vanities - have been ousted by "quants", the nerdy brainboxes
who design and run the computer programmes.
In a recent post-script to his novel written for the Daily Beast, Tom Wolfe
lamented the emasculation of his anti-heroes, renaming them "Eunochs of the
Universe".
Closer servers, straighter cables
Firms such as Lenterman's make their money by scraping a tiny profit margin on
an unthinkably huge volume of rapid-fire buying and selling.
Different algo traders use very different strategies. But they all share the
need to identify trading opportunities - fleeting discrepancies between the
available market price and where the computer deems the price ought to be - and
then react to them faster than anyone else.
Race to zero
The options available late last year for anyone wanting to send an electronic
trade order between New York and Chicago:
Route Complete Length (miles) Speed* (milli- secs)
Original fibre optic cable
1980s
c1,000
14.5
Spread Networks fibre optic cable
August
2010
825
13.1
McKay Brothers microwave beams
July
2012
744
9
Tradeworx microwave beams
Late
2012
c731
c8.5
Source: Wired Magazine
It is called the "race to zero". And it has led to the investment of billions
of dollars in faster, smarter computers, and in the fastest possible
connections.
At stock exchanges across the planet, traders pay hefty fees to "co-locate"
their servers directly next to the exchanges.
And hundreds of millions have been spent on building straighter cables to shave
a few fractions of a second off the time it takes to transmit orders between
the world's big trading centres: London, New York, Chicago and Tokyo.
All this can seem a little irrational when the UK and US governments are
struggling to scrape together enough money to upgrade the infrastructure needed
to ferry humans from one place to another.
Flash Crash
There is, however, a darker side to this rush to computerise.
For example, accidents can happen.
Last August, the hi-tech financial firm Knight Capital was brought to the verge
of bankruptcy by an algorithm that went haywire, racking up more than $440m of
losses in just 45 minutes before it was switched off.
Perhaps the most famous mishap was the now legendary Flash Crash, at 2.45pm in
New York on 6 May 2010.
In a few minutes the New York Stock Exchange plunged, and then just as suddenly
recovered again. Share prices in some firms, such as the consultancy Accenture,
plummeted to a fraction above zero, while Apple soared to $100,000.
For months afterwards, nobody could explain what had gone wrong.
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For days afterwards, the New York Flash Crash of 6 May 2010 left investors and
regulators perplexed
The official US regulatory investigation said it had been triggered by a single
order, placed by a large institution, using an algorithmic trading strategy.
But, what made things far worse was a "hot potato" effect: amid the confusion,
one by one the robot traders tried to cut and run, and the stock exchange's
computers got swamped.
'Outright manipulation'
The new algorithmic traders have also been accused of some fairly old-school
nefarious behaviour.
Eric Hunsader, of the US data analysis firm Nanex, says miniature versions of
the Flash Crash happen in individual stocks many times a day, and he alleges
that a lot of it is outright manipulation.
He has produced charts depicting the weird and wonderful behaviour of markets,
as computers seek to outfox one another by rapidly generating and then
cancelling thousands of orders a second.
Nanex chart showing trading during the Google flash crash A Nanex chart
illustrating the Google mini-flash crash of 22 April this year
"We allow people with faster connections to place and remove offers or bids
faster than the speed of light can deliver that information to the other market
participants."
And he is not the only one concerned that some computerised traders might be up
to no good.
"Unfortunately the nature of markets is that there always is potential for
abusive activity, and with very, very fast trading, these things can happen
very, very fast," says Martin Wheatley, head of the UK's newly created
Financial Conduct Authority.
"Frankly, for the regulator, it creates a problem trying to pick out from the
vast amount of data trades that potentially might be abusive."