Losing our minds « Mining Blog

Losing our minds

29. August 2011,

I’ve just read one of the most “gob-smacking” articles in years.

While most of are aware that electronic trading – in shares, derivatives, commodities – are now made in split-seconds, we probably fondly imagined (at least I did) that there was some semblance of direct, hands-on, discriminating, intelligence behind them.

And that an actual human being would intervene to correct, if not avert, any anomaly in the system – thus avoiding a potential financial crisis.

But, according to an article published recently in the London Review of Books (19 May 2011) by a professor of sociology at Edinburgh University, Donald MacKenzie, such deals across the wire, whether to buy or sell shares , options or commodities, are commonly undertaken in microseconds (millionths of a second) – those done in milliseconds are now considered too slow.

Indeed, the London Stock Exchange’s so-called “Turquoise” trading platform claims it can now execute a trade in as few as 124 micro seconds. (MacKenzie helpfully points out that no human being can react to any event whatever in less than 140 microseconds)

(For your information this platform is organised by Turquoise Global Holdings Limited (“TGHL”), a consortium of 12 leading global investment banks which aim to “engender greater competition in the secondary trading of European equities, – both as cash deals and as derivatives”. It also trades in ETFs (Exchange Traded Funds, Global Depositary Receipts, American Depositary Receipts, Exchange Traded Currency funds and Exchange Traded Commodity funds – For explanations of these terms, please go to:
http://moneytometal.org/index.php/Glossary

Says MacKenzie: “ Human beings can, and still do, send orders from their computers to the matching engines, but this accounts for less than half of all US share trading. The remainder is algorithmic: it results from share-trading computer programs. Some of these programs are used by big institutions such as mutual funds, pension funds and insurance companies, or by brokers acting on their behalf.”

MacKenzie explains that the goal of these “execution algorithms is to avoid losing money while trading. The other major classes of algorithm are designed to make money by trading…Electronic market-making’ algorithms replicate what human market makers have always tried to do – continuously post a price at which they will sell a corporation’s shares and a lower price at which they will buy them, in the hope of earning the ‘spread’ between the two prices – but they revise prices as market conditions change far faster than any human being can. Their doing so is almost certainly the main component of the flood of orders and cancellations that follows even minor changes in supply and demand.”

Inevitably there had to come a point at which this system nearly imploded. And it did, in May 2010, when a sell order worth US$4 billion caused the price of NY share and futures contracts to topple by 6% in just five minutes – and nobody really knows how it happened. Five minutes is obviously an eternity in this new “micro-universe of macro wheeling and dealing” .

ut , if it hadn’t been noticed, it could have triggered a meltdown of the financial system that would have left that of 2008 looking like a brief bank holiday stroll. The collapse didn’t occur, according to MacKenzie, because the anomaly was noticed within five seconds (sic) and “corrected”.

What worries MacKenzie however is not so much the system itself – he seems to believe it’s capable of correction before it crashes, bringing all of us down with it . He apparently accepts that this type of computer-to-computer trading will carry on – and indeed increase. What it mainly requires is more warning signals, and presumably even faster ones – by a trilli second, perhaps?

To me, however, what he’s outlined in a highly stimulating presentation is a point in human-generated activity, at which we have already literally “lost our minds”

Donald MacKenzie’s article is available free at:
http://www.lrb.co.uk/v33/n10/donald-mackenzie/how-to-make-money-in-microseconds

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