Tuesday, January 18, 2011

Wall Street 2 Money Never Sleeps 1

More information on how computers are affecting Wall Street and the economic heartbeat of the world.

Since our last post we have learned of some more incredible things being done by the major stock firms in Wall Street.

Need For Speed And The Flash Crash of 2010
click to enlarge via NYT
The essential need for firms to be the first to spot trends and act on them is unrelenting.  On May 6, 2010 Wall Street experienced its first "flash crash."  This crash was the fastest in Wall Street history.  In  basically 15 minutes the Dow Jones Industrial Average went down almost 1,000 points, about $1 trillion dollars.  Then within the next 15 minutes it gained back over 600 points.  The problem was traced to a computer that had begun a large sell order automatically, based on the instructions in its software program.  This is the fastest loss in the equity market in U.S. history.  Why are these high frequency programs so important to Wall Street firms?  Because they can make millions of dollars from them.  According to the New York Times article dated July, 24, 2009, entitled Traders Profit With Computers Set At High Rate,
...PCs have been unable to compete with Wall Street’s computers. Powerful algorithms — “algos,” in industry parlance — execute millions of orders a second and scan dozens of public and private marketplaces simultaneously. They can spot trends before other investors can blink, changing orders and strategies within milliseconds.
High-frequency traders often confound other investors by issuing and then canceling orders almost simultaneously. Loopholes in market rules give high-speed investors an early glance at how others are trading. And their computers can essentially bully slower investors into giving up profits — and then disappear before anyone even knows they were there.
High-frequency traders also benefit from competition among the various exchanges, which pay small fees that are often collected by the biggest and most active traders — typically a quarter of a cent per share to whoever arrives first. Those small payments, spread over millions of shares, help high-speed investors profit simply by trading enormous numbers of shares, even if they buy or sell at a modest loss.

The best explanation we could find on youtube on what high frequency trading is was done by an 8th grader named William Arnuk for an 8th grade civics project!  It is well produced and very clear.  We post it here for your betterment.  If you cannot see the embedded video here is the link: http://youtu.be/9ddoha-34gg.

 For more information on high frequency trading we have provided a playlist of more videos from various sources.  If you cannot see the embedded video here is the link: http://tinyurl.com/62aymz5.

Flash Trading And Mini Flash Crashes
Flash trading and high frequency trading are not the same thing.  Flash trading is one part of high frequency trading. Here is a detailed but concise explanation of what flash trading is.  In flash trading the computers are between a sellers request to sell shares of a stock and the general population of potential buyers.  This gives the owner of those computers a first shot at buying the stocks before anyone else sees it.  These flash trades not only make the buyer pay the highest price possible, but also can shape and manipulate the market.
An M16 assault rifle can fire a bullet 100m in just over one tenth of a second. In that same amount of time, the London Stock Exchange can now execute 800 trades."
Financial Times

Progress Energy via NYT
On September 27, 2010, Progress Energy, a 102 year old utility in North Carolina lost 90% all of its stock value in a matter of seconds.  No one had any idea why.  After a tense call from the Chief Financial Officer of the company to the New York Stock Exchange, the company was told that it all been a mistake.  Many experts feel that these mini crashes (due to a mistake by sell order which placed the sale of the shares at $4.57 instead of $44.57) can cause huge havoc due to automatic computer systems that sell off shares of stock.  Since the last crash of May 2010, a "circuit breaker" has been installed and this kicked in the case of Progress Energy as well as others.  This circuit breaker stops all trading for 5 minutes to reduce a chance of panic selling.  But some experts are not convinced that this is enough.  They see the inherent instability of high frequency trading as creating a dangerous "wild west" atmosphere in the U.S. equity markets.

Here we include two videos to explain this procedure.  If you cannot see the embedded video here is the link: http://tinyurl.com/4mzurbg.

"The greatest danger is the age-old sin of idolatry. Financial markets are alive but a model, however beautiful, is an artifice. No matter how hard you try, you will not be able to breathe life into it. To confuse the model with the world is to embrace a future disaster driven by the belief that humans obey mathematical rules."
Paul Wilmott, Financial Modelers' Manifesto

In Part 2 of this series we will speak about the latest techniques of investigating videos, twitter, blogs and the internet to determine where the market will head and to buy and sell based on this information - being read not by people but by computers.

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