High Frequency Trading, ECNs and the Green Light

by Scott

I’ve got to do something to get my money back quickly. This calls for an aggressive trading strategy. Take 50% of my money and put it in the Blue Chips: Transatlantic Zeppelin, Amalgamated Spats, Congreve’s Inflammable Powders, US Hay. And sink the rest of my money into that up-and-coming Baltimore Opera Hat Company.

That should set things right again, eh boys?

–Montgomery Burns

There is a radio station here in SF that still runs trivia contests, where if you call in with the right answer you will win tickets to some concert. What a holdover from the pre-internet days. It’s kinda crazy every time I hear the DJ announce the trivia question, trying to jazz up the excitement and making presumptive comments about the audience’s collective brain racking. It’s like “why is he still doing this?? As somebody endowed with human intelligence (DJ jokes aside) doesn’t he know the words coming out of his mouth are completely absurd?! He must realize that the answer to this trivia question can be readily googled?!” I guess the answer to why they keep doing it is: “It’s part of the radio station formula. And until we figure out what’s next, F-it, just keep doing it.”

Sometimes you’ve got to wonder if the Stock Market isn’t really a holdover 1920′s institution.  It made sense back then as a way of organizing capital, but now, maybe like a capital market’s Coase11. Coase, R. H., The Nature of the Firm (1937). Economica (new series), Vol. 4, Issue 16, p. 386-405 1937.  [pdf], the barriers it was created to overcome are no longer barriers.

Just put your 401k into a PE fund. No need for:

401k -> Mutual Fund -> Mutual Fund PM -> Stock Market -> BOD -> CEO

It’s a neat idea that you could be ignorant to the world, walk up to the proverbial “teller window” and buy 1-one-billionth of a company and not get screwed.  But the “not get screwed” part is, seemingly, becoming just too hard to police.

Credit must be given to somebody for sort of getting ahead of the perception curve; “the market for the next century,” “Island,” “Archipelago” brand ECNs, and all.  But when you hear of stuff from the “Business Academics” like High Frequency Sentiment Analysis22. Robert P. Schumaker, Hsinchun Chen, “A Discrete Stock Price Prediction Engine Based on Financial News,” Computer, vol. 43, no. 1, pp. 51-56, Jan. 2010 [link] and know that the practitioners are probably 5 iterations beyond this today, you’re really reaching the end of that rationale road.

And it brings to mind a  provocative book called “The Collapse of Complex Societies33. The Collapse of Complex Societies. Joseph A. Tainter. Cambridge: Cambridge University Press, 1988. [link]”. The thesis is: as complexity in society grows, so does the ability of the elite to exploit that complexity until the whole thing comes tumbling down.  If the CDO^2 + corporate-capture-of-congress-axis doesn’t spell that out, I don’t know what does. And the most comical sketch of that show is the “skin in the game” provision whereby the manager of the assetization would need to retain risk ownership.  I don’t know if it’s still in the reform bill or not, but I cannot imagine that there are not 101 legal structures to circumvent this provision “on-the-shelf” up and down law firms on Madison Ave. And I can’t believe there are not a 101 hedging strategies “on-the-shelf” in Greenwich.

And so it goes.

Let’s fine tune the rules to avoid the last “flash-crash”…

Let’s tweak BOD incentives again…

I wish there was a better analogy then “fighting the last war” because it seems to me all of the additional complexity (and tight coupling) is the raw material for further exploitation and as I was taught as a youngster: “Positive Feedback Loops are Dangerous.”