Darwin’s Deceptive and Dangerous Devices October 26, 2011
Doug Wakefield
“The film depicts a future in which
reality as perceived by most humans is actually a simulated
reality created by sentient machines to pacify and subdue the
human population, while their bodies' heat
and electrical activity are used as an energy source. Upon learning this,
computer programmer ‘Neo’ is drawn into a rebellion against the
machines, involving other people who have been freed from the ‘dream world’ and
into reality.”
Comments from Wikipedia
regarding the movie, The
Matrix
In
the last month, investors have read headlines like Europe
has six weeks to find debt crisis solution, warns Chancellor George Osborne
(Sept 23), In
the Absence of a Credible Plan we will have a Global Financial Meltdown in Two
to Three Weeks, [states] IMF Advisor (Oct 6), and G20
Tells Eurozone to fix debt crisis in 8 days (Oct 16). As I release this
article, a headline reads, S&P
500 Extends Best Month Since ’74, Euro Rises on Debt Accord, proving that
the deal completed last night in Europe was “a success”. The worst is now
behind us. I guess the “crisis” was all just hype, right?
Yet,
questions still come to mind. “How can the Euro and stock indices in the US and
Europe rally so sharply in 18 trading days with such news background? Are
‘investors’ optimistic or crazy? Did investment managers always believe that
‘the solution’ was always going to come through, and that smooth sailing is now
ahead for Europe and global markets”? The simple answer may not be one you
think about day to day when looking at markets, but the data proves it is at
the core of all rising and falling prices across our markets, and it has no
emotions; the computer. Without extremely powerful and fast computers, the
world we have seen unfold over the last few years could never have taken place.
In
my September 21st article, Peeling
Onions, I stated that “This article is the first in a series on peeling
back layers of false concepts in our minds that millions of investors have been
indoctrinated to believe since the 1980s. Since these ideas allow us to explain
our world in a much more controlled fashion, they allow us to live in our own
bubble world.” In this second article,
we will continue along this same theme; the topic, extremely fast computers
that make more than 50% of the stock trades that happen daily in U.S. markets.
As we examine various sources of data and comments by various experts, each of
us must decide if the financial markets of 2011 operate the same way as the
financial markets of 1991 of even 2001. Are these tools helping foster an
environment where more power is placed in fewer hands, thus evolving more into
Darwin’s “survival of the fittest”, or do these tools reveal financial markets
are moving back toward the idea that “all men are created equal”? When the
crowd is winning, these are just philosophical questions. When the crowd is
losing, these questions become extremely pertinent to their own personal plans
and lives.
The
Order in the New World
If
we were to visit the New York Stock
Exchange website, we could learn that this institution, like many
institutions in our world today, is one with a very long history.
“On May 17, 1792, twenty-four stockbrokers gathered
outside 68 Wall Street under a buttonwood tree to sign an agreement that would
establish the rules for buying and selling bonds and shares of companies. The
Buttonwood Agreement, as it is known, is so named because the tree served as
the regular meeting place for these pioneers of Wall Street. The signers of the
Buttonwood Agreement drafted their first constitution on March 8th, 1817, and
named their nascent organization the New York Stock & Exchange Board.”
The
NYSE exchange stayed the NYSE until 2006, when it merged with Archipelago Holdings (acquired the Pacific
Stock Exchange in 2005) to form the NYSE Group, which subsequently merged with
Euronext (who went public in 2001 after merging the Paris, Brussels, Amsterdam
exchanges in 2000 and acquiring the London Financial Futures and Options
Exchange, and the Lisbon Exchange in 2002) in 2007. Even in 2011, the “global
financial marketplace group”, continues to change form:
NYSE
Shareholders Approve Merger With Deutsche Boerse, Futures Mag.com, July 7, ‘11
“NYSE Euronext (NYSE: NYX) today announced that its
shareholders have approved the adoption of the business combination agreement
with Deutsche Boerse (XETRA:DB1) and related proposals.”
NYSE CEO: EU
Regulations To Ease Competitive Concerns on Deutsche Deal, Wall Street Journal, Oct 24 ‘11
“NYSE Euronext (NYX) and Deutsche Boerse AG (DB1.XE,
DBOEF) aim to sell their proposed merger to European Union regulators as a deal
that will make the region more competitive on the world stage and a safer place
to invest and hedge risk, according to the top executive of NYSE Euronext.”
I
believe we could all agree that things have changed dramatically, not only a
great deal from its founding days in 1792, but in the previous decade alone. As
the largest global conglomerate in financial markets continues to morph, so
also do the requirements of “the customers” of the exchange. The next comments
can be
heard (or read)
in the report released by 60 Minutes on June 5, ’11, Wall Street: The Speed
Traders.
“For
150 years, the floor of the New York Stock Exchange was the center of the
financial world, the economic engine that helped American business raise
capital and create jobs.
Today
it is still the public façade of Wall Street, and a television backdrop for
reporters relaying financial news. But less than 30 percent of the trading is
conducted there now, and the specialists and the noise of the floor is being replaced
by the speed and quiet efficiency of computers, and the action has moved
elsewhere.”
The images in our
minds continue to be ones millions chose to believe when investing for their
future. We place our funds in the capital markets, and these funds go into
businesses that grow, and as they grow, they create more jobs, and more jobs
means more spending, and thus our investments increase in value. However, it is
obvious, that the dominant force behind price movements, both up and down, are
driven more and more by ever faster computers rather than humans pondering
whether their decisions are good investments to hold and increase, or poor ones
to sell.
“Most
people don't know it, but the majority of the stock trades in the United States
are no longer being made by human beings. They're being made by robot
computers, capable of buying and selling thousands of different securities in
the time it takes you to blink an eye.
These
supercomputers - which actually decide which stocks to buy and sell - are
operating on highly secret instructions programmed into them by math wizards,
who may or may not know anything about the value of the companies that are
being traded.
It's
known as "high frequency trading," a phenomenon that's swept over
much of Wall Street in the past few years and played a supporting role in the
mini market crash last spring that saw the Dow Jones Industrial Average plunge
600 points in 15 minutes.” [Wall Street: The Speed Traders, 60 Minutes, June 5
‘11]
As a specific
example of how high frequency trading differs from the average investor at a
brokerage firm, we turn to Manoj Narang, owner of Tradeworx, the only firm
willing to be interviewed by 60 minutes:
“…Narang
told correspondent Steve Kroft, "Humans are not involved in the trading
because humans are way too slow to trade on the kinds of opportunities that
we're trying to capture. We're trying to capture opportunities that exist for
only fractions of a second."
The
Tradeworx computers don't care where a stock is going to be trading next year,
next month, next week or even tomorrow, because they are going to be in and out
of it on the same day, in a matter of minutes.” [Ibid]
What no one
outside the world of trading can grasp, is that picking up pennies can be
extremely profitable.
“What
Narang and other high frequency traders tell their computers to do is to make a
profit of a penny or less, 40 million times day….
Asked
how successful he and his firm have been, Narang told Kroft, ‘We've had two or
three days in a row where we lose money. But we've never had a week, so far,
where we lost. We've never had a month that was a loser for us.’” [Ibid]
If this sound
unbelievable, consider these points I pulled from Welcome
to the Machine: High Frequency Trading Domination, an article released
on Oct 17 ’11 written by Liz Ann Sonders, Chief Investment Strategist at
Charles Schwab:
·
Trading speeds are
measured in milliseconds (thousandths of a second), and even more recently in
microseconds (millionths of a second) and nanoseconds (billionths of a second).
·
HFT
firms are usually trading their own capital and rarely hold positions
overnight.
·
According to
several sources, including TABB Group, Aite Group and Thomson Reuters, HFT now
accounts for between 55-75% of trading volume on average, with some days even
higher.
·
On August 8, the
Monday after S&P downgraded US debt, the Dow Jones Industrial Average fell
by 635 points. Volume on the New York Stock Exchange was the fourth highest on
record. TABB estimates record profits of $60 million that day for HFT firms.
Now chew on this
idea. When we read news headlines that state that investors bought or sold
certain markets for some specific reason explained in a news article, and yet
the majority of the trades on the largest exchanges in the world are electronic
and can react to changes almost instantaneously, are we really watching a crowd
of investors reacting to the latest news, or computers reacting to changing
math patterns? When world leaders come out with “the solution”, and the markets
move up or down within minutes, was this a reflection of a group of traders
waiting to “hit the button” or the quiet hum of massive computers looking for
changes in math patterns in the markets that cause their algorithms to send out
trades in milliseconds once “the event” triggered a change in price in a stock,
stock market, or even the largest currencies in the world? The significance of
these questions is enormous, and changes not only the way we must look at
financial markets, but our own personal futures.
Bring in the
Big Guns
On Friday, Oct 14th,
according to the Financial Times article, Regulators
plan coordinated HFT monitoring,
the UK FSA and the US SEC hosted a roundtable discussion in London with 40
officials representing 16 countries in an effort to develop a plan to monitor
high speed trading. After the meeting, Mary Schapiro, chairman of the SEC,
stated that “the meeting was a tremendous success in advancing such cooperation
on market structure issues”, and that the HFT issue is “increasingly vital in
ensuring the safety and soundness of our markets and protecting investors”.
When one reviews the opening remarks found in the U.S. SEC (Securities and
Exchange Commission) and U.S. CFTC (Commodities Futures Trading Commission) Preliminary Findings
Regarding the Market Events of May 6, 2010 (i.e. the flash crash) released
on May 18, 2010, and then considers the enormous volatility in world markets
since July, it is amazing the parallel in world events. It is as though someone
hit “instant replay”, only this time, the image was “of course they will fix
this problem” as equity markets had rallied 17 days before today’s “crisis is
solved” rally - assisted by fast speed computers in the futures markets last
night before stock exchanges opened in Europe and New York this morning.
“May 6 [2010]
started with unsettling political and economic news from overseas concerning
the European debt crisis that led to growing uncertainty in the financial
markets. Increased uncertainty during the day is corroborated by various market
data: high volatility; a flight to quality among investors; and the increase in
premiums for buying protection against default by the Greek government. This
led to a significant, but not extraordinary, down day in early trading for the
securities and futures markets.
Beginning shortly
after 2:30 p.m., however, this overall decline in the financial markets
suddenly accelerated. Within a matter of a few minutes, there was an additional
decline of more than five percent in both the equity and futures markets. This
rapid decline was followed by a similarly rapid recovery. This extreme
volatility in the markets suggests the occurrence of a temporary breakdown in
the supply of liquidity across the markets.
The decline and rebound of prices in major market indexes
and individual securities on
May 6 was unprecedented in its speed and scope.”[Italics mine]
If financial regulators did not have enough on their plate
already, as they seek to
monitor these lightning trading storms occurring daily around
the globe, it would appear that there is yet another risk that was far off the
radar screen during the recent “fix the
European debt crisis” rally.
According to an Aug 20 ’11 article in The Australian News, Pentagon
Prepares for Economic Warfare, another “first ever” event took place
during the last few years, and must be considered by all individuals concerned
with the “risk on” trade.
“The
guests were assembled in the Warfare Analysis Laboratory, surrounded by
uniformed officers from the highest levels of the Pentagon and a dizzying array
of screens normally used to simulate nuclear world war.
The
gentlemen were called to order and the games began.
‘If
you imagine the war room in Dr. Strangelove, you're not far off,’ says
participant James Rickards.
Yet
this was no traditional battle game, but rather the Pentagon's first
economic war game, and the authorities are loath to talk about it….
Rickards
is not a soldier but a banker. He was joined in the war game by dozens of his
Wall Street colleagues, flown in from Manhattan to this bunker at the Applied
Physics Laboratory in Maryland for the two-day event in 2009, when the Pentagon
started to get really alarmed….[italics mine]
Once again, this
is a systemic level of risk none of us even want to consider.
“They were sent
into ‘bunker rooms’ and told to use financial or economic tools - currency,
debt, stocks, gold - to bring their enemies to their knees. Everything was
conducted via computer, and they could be as devious and ruthless as they
liked….
Paul
Bracken is a professor and expert in private equity at the Yale School of
Management who serves on government advisory committees at the US Department of
Defense. He was one of the key players behind the 2009 economic war game, and
the smaller versions that have been played out since.
‘The
atmosphere that day was one of surprise at the magnitude of the threat,’ he
says.
‘The
Pentagon people were used to dealing in terms of military battles: how many
ships, how many missiles. This opened up whole new strategies.’”
As we consider
the ability of computers to produce what is now very close to a quadruple
top in the NDX 100 as we continue through Q3 earnings, is it really
beneficial to pick up pennies daily, when computers can also generate the same
emotional swing among traders and investors today that slammed those caught up
by the South Sea Bubble almost 300 years ago? Maybe “risk on- risk off” is not
a new trading terminology after all.
[Chart from Sept
21st article, Peeling Onions]
“Alexander Pope,
writing to Bishop Atterbury on 23 September (the bubble popped in August 1720),
had finally decided where he stood on the subject of the South Sea (Co). Gone
was the ebullient speculator of the New Year to be replaced by the autumnal
moralist, intoning in classical style against the vices of the age:
‘The fate of the South- sea Scheme has much sooner than I expected verify’d what you told me. Most people thought it wou’d come, but no man prepar’d for it, no man consider’d it would come like a Thief in the night, exactly as it happens in the case of death….They have dreamed out their dreams and awakening have found nothing in their hands.’ [Devil Take the Hindmost: A History of Financial Speculation (1999) Edward Chancellor, pg 84]
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Doug Wakefield
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