One day back in 1987, a broker with a background in software decided to (literally) hook up his computer to that of a Nasdaq terminal, thus forever transforming the way Wall Street does business. So successful was this development that SEC regulators and other business entities were convinced that a bank of traders were working behind the scenes, and it wasn’t until later when the full power of computer trading became appreciated.
Fast forward to the present time: now, like onto Moore’s Law, computer trading is starting to hit some major walls.
Trading – whether in Wall Street, Singapore, the SSE Composite (China Stock Market) Russian, Turkish, the Borse – it’s about speed: hear the words being shouted out, watch the numbers fly and the trade slips go fast. And now with data processing, it’s much, much faster.
But how fast can fast go? It’s an inherently loaded question because just as firms seek the fastest and greatest processing speeds, the seconds are dwindling literally into multi-milliseconds. The ROI (Return On Investment) on such systems are increasingly becoming ludicrously stretched thin: how much would you be willing to spend for a system that shaves off .00001 of your trades? Some would argue that such cost savings are cumulative: a .00001 here and a .00001 there adds up to real time and money – right?
But it’s more than just speed: it’s also about algorithms. The trick now is to sense trends and trade patterns: seeing where a particular market segment is going – say, futures, pork bellies or commodities – and viola! you make your play. As the great Wayne Gretsky would say, “a winner does not skate to where the puck is, but rather to where the puck is going.”
But the inventor of the computer trading, one Thomas Peterffy, is now no longer sure. As he stated in an interview on NPR (http://www.npr.org/blogs/money/2012/08/21/159373388/episode-396-a-father-of-high-speed-trading-thinks-we-should-slow-down), gains from faster speeds are now uncertain and must be balanced against the inherent risks involved: faster trading means the potential for going into the wall at higher rates of speed – and far greater losses.
High speed trading does have its risks. And surprise! Regulation is not keeping up. But what is to be done? In a new paper, “Process, Responsibility and Myron’s Law”, an economist, Paul Romer, argues that we need to start paying attention to the dynamics of how new rules are developed and referred to Myron’s Law – that is, given enough time, any particular tax code will end up collecting zero revenue, as loopholes are discovered and exploited. Laws must adapt to changing conditions and tools, else they fail to do their duty.
Romer’s solution? Simple – and effective (and to be certain, rational business types will be open to its approach).
Keep it simple.
Unlike adapting the approach of, say, the Occupational Safety and Health Administration (OSHA) which has a painfully detailed and somewhat contradictory rule, 1926.1052(c)(3), about the height of stair-rails (as but one example) we compare this approach to that of the FAA (Federal Aviation Administration) which simply requires planes to be airworthy to the satisfaction of its inspectors. Romer argues financial regulations resemble the OHSA’s rule 1926.1052(c)(3) more closely than the FAA’s “airworthy” principle – and that this is a problem. With the addition of new technology (and it only promises to get more complicated as time goes on) financial regulations as they presently stand are not going to be truly effective.
Another case in point is that of GE (General Electric): using their dedicated staff of professional tax attorneys GE was, back around 2009, on the hook for federal taxes approximately $12,000 – and this from a firm worth billions. All perfectly legal.
As the Roman historian Tacitus said, “corrupt is the land with many laws” – the point being that the more laws that are on the books, the more likely you’re going to have loopholes and deals made to avoid those laws. The same will go for computer trading and the general stock market; unless these issues are addressed now it’s only going to get more sticky and complicated, with the ever-rising potential for crashes and financial failures which will only make the recent crash seem like a mere holiday in comparison.
See the puck go flying across the ice and into the stands,…