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Comment by jordigh | Hacker News Reader

I've always found the whole prospect of algorithmic trading morally dubious. Is algorithmic trading overall a good thing? Is it something we should be encouraging? Can I do good in the world by working in algorithmic trading? Would people become algorithmic traders out of a belief that they're improving the world, and would gladly do it even if the pay was slightly lower than other software developer jobs?

I really don't know. The only reasons I've ever been marginally enticed to do it is that it looks like a fun problem and people make a lot of money off it. But it's hard to beat the job satisfaction at my current workplace. Right now I can release free software, which helps diagnosing and treating neurological diseases.

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Algorithmic trading is intrinsically neither good nor bad. It's kind of just a natural progression in the markets once easily programmable computers and high-speed networks came along.

How algorithmic trading is used, however, is another story. Humans are still the ones who bring the intent to technology, using it for good or evil. But it may interest you to know that a lot of malicious trading in the markets is not done by algorithmic traders, but by teams of manual traders working in concert to place manipulative trades that cause the market making algorithms to move the market in certain ways. (Source: I work at an exchange, and this is what our regulatory and compliance dept. says all the time.)

Why are the market making algorithms so easily exploited?

Most market making algorithms work like -

  Market state                                     -> price forecast
  Price forecast + other factors (risk, liquidity) -> trading decision

If you know (or have a good guess) how the algorithm works, you can work out what state of the market would lead to a price forecast in your favour, i.e. would lead to the algorithm offering liquidity at a price favourable to you.

You then manipulate the state of the market to look like that (generally this is "spoofing" or "layering"), wait for the algorithm to respond, and then take advantage of the favourable liquidity it offers.

When people calibrate their algorithms, they use real market data. Most of the time, someone isn't actively manipulating the market, so the model is not calibrated to handle those situations.

I know someone who used to work at an algorithm trading firm and did electronic market making. He said they used to go to great lengths to program their algorithms to try to spot this sort of manipulation, but it's a hard problem because you're fighting against a cloud of bad traders who are coordinating their efforts across multiple market centers.

I have to say, the regulatory dept. at the exchange I work for does an excellent job of monitoring for any funny business. They have some nifty real-time tools that are scriptable and can replay the state of the market at any point. It's really cool stuff!

Because the markets are infinitely variable and it's impossible to program every possible scenario into these algorithms.

If trading is providing a valuable service for society - the finance industry normally claims that it is ("liquidity in the markets" etc) - then it's morally correct to get algorithms to do this efficiently and effectively.

This assumes that algorithms are able to deal with edge cases well enough, which I doubt strongly (e.g. Black-Scholes is a massive oversimplification and traders don't even understand that fully) and I don't personally agree with the premise that this is valuable for anyone outside the industry - in particular the distribution of wealth causes severe and increasing problems in society. Martijn also makes good points, although I don't think these are specific to trading.

Your job sounds cool! Nice one and thanks for doing it :)

It's more than liquidity, it's a combination of liquidity and valuation. The best analogy I can could up with is the following:

Blaming the finance industry for it's services is like blaming the shipping industry. The shipping industry doesn't produce anything, it merely generates value off your goods. If it didn't exist however, you'd have to haul goods yourself, at lower efficiency, and without immediate availability. It's not absurd to expect this industry to profit for that. Of course, if there is not enough competition, or if there is collusion between shipping companies, you're going to pay an "unfair" price (for most definition of fairness).

The financial market has enough competition that most modes of unfairness are almost fully compensated for, and whether it is fair will really depend on your definition of fairness; but it's safe to say it's almost fair for most definitions, I believe. If you're trading a major stock like Apple you can be sure you'll trade for a value near the market's best estimate of what the true long-term value of that stock.

Now think of a farmer selling grains. He, an ordinary farmer, has access to the global consensus of the value of it's product at any time: he can be sure he won't be ripped off and can sell for no more or no less than the value of his goods; he can choose to sell at any time, he'll be able to do so instantly. That's a really valuable service.

The financial industry is necessary for the progression of any industry these days, but you must acknowledge the fact that most leaders of the financial industry don't care about externalities. They are only interested in making money both for themselves and their companies'.

There's nothing wrong with that. The basis of capitalism essentially is that a well designed system permits each corporation to act looking exclusively at profits, while benefiting the whole society. I argue that, save for some important exceptions that need to be dealt with, the financial industry currently satisfies this principle.

So where are the alternative valuations? Where are the alternative business models that don't emphasise stock ownership and stock value? Where is free public access to the freshest financial data and hyper-speed trading platforms?

Why do you never see anyone arguing that a bank balance is just a bit pattern, and if you copy a bit pattern from one place to another you're not actually stealing anything?

You regularly see this argument from opponents of DRM who are justifying the copying of artistic work. Why do they never apply it to finance?

What gives money a special pass on this?

If you can't answer that question without thinking it through - i.e. without just responding emotionally with an 'OMG the world would end if everyone did that' - then you can't make a statement like 'most modes of unfairness are almost fully compensated for' and expect to get free pass on it either.

>If you're trading a major stock like Apple you can be sure you'll trade for a value near the market's best estimate of what the true long-term value of that stock.

There is no such thing as a market. There are only people, and politics, and political relationships.

Finance and 'markets' are just quantified politics, which - like all political systems - happen to privilege one particular set of actors.

>he can be sure he won't be ripped off and can sell for no more or no less than the value of his goods; he can choose to sell at any time, he'll be able to do so instantly.

If you knew anything about farming you'd know that this is exactly what doesn't happen. What actually happens - in the UK at least - is that buyers form cartels and dictate prices to sellers.

Smarter countries like Canada regulate prices to keep farms working. (Forcing a farm to close because of one bad financial year is dangerously stupid if you want to keep feeding your population.)

But manipulation couldn't happen in the pure world of finance, surely?

http://en.wikipedia.org/wiki/Forex_scandal

But that couldn't happen to stock prices, could it?

https://ideas.repec.org/a/tpr/restat/v73y1991i2p309-17.html

The alternative valuations are right there in the market. If "alternative valuations" I were to place an order to purchase 100 shares of apple stock at $10 per share simply because I favor an alternative valuation I could do so but my order will not be filled. This is because the valuation is not correct.

"alternative business models" Publicly traded companies emphasize stock value because it is their duty to do so. The owners of the company have a right to collectively demand this. If the company fails to promote the value of the stock then the owners will sell their stock and the price will adjust to reflect this increase in supply/fall in demand.

"free public access to data/hyper-speed trading platforms" They are publicly available but they are not free. Data is a good, goods cost money. Believe it or not it takes quite a lot of effort to deliver these products.

"bit pattern" What are you talking about? DRM in finance? You aren't making sense here.

"There is no such thing as a market" Yes there is. People buy and sell companies and commodities on various exchanges. These exchanges are called markets.

"buyers form cartels and dictate prices" The market dictates prices. There are market makers who are legally obligated to buy and sell within a certain range of the free market price. This ensures liquidity and it is not some sort of scam.

"manipulation couldn't happen" Your sarcasm is obvious. People commit crimes, it doesn't mean that the whole system is broken. Often they also go to jail for these crimes.

> So where are the alternative valuations?

You can call up a bunch of buyers directly if you want. You might even get a better price for your efforts.

> Where are the alternative business models that don't emphasise stock ownership and stock value?

Nonprofits exist. So do corporations with particular requirements in their charter. What exactly are you after?

> Where is free public access to the freshest financial data and hyper-speed trading platforms?

If you want a consolidated feed at the standard 5s latency you can get it on standard terms at a reasonably proportionate price. If you want dedicated fast feeds there are companies who sell them. No-one's giving it away for free and why would they?

> You regularly see this argument from opponents of DRM who are justifying the copying of artistic work. Why do they never apply it to finance?

Because everyone knows the value of money or stock is in its artificial scarcity, whereas the value of art is supposed to be actual value.

> http://en.wikipedia.org/wiki/Forex_scandal

Forex is a jungle, in part because there aren't public markets and exchanges the way there are for stocks.

> https://ideas.repec.org/a/tpr/restat/v73y1991i2p309-17.html

Huh? That's saying that stock prices fall because the companies the stocks were of - ordinary, non-finance companies - had been price-fixing (and can no longer expect to profit from that now that they've been indicted).

> He, an ordinary farmer, has access to the global consensus of the value of it's product at any time: he can be sure he won't be ripped off and can sell for no more or no less than the value of his goods; he can choose to sell at any time, he'll be able to do so instantly. That's a really valuable service.

Considering that farming has become uneconomic in my home country (with associated structural problems that will play out in the longer-term), you have really failed to convince me that this is a good thing.

Meanwhile, I personally set my own prices and value my own services successfully without there being a commodity market in tech services (just as farmers do with local distributors, in truth). Is the financial industry really providing this service? If so (which I doubt), what percentage of the financial industry is concerned with such practical matters?

Farming becoming economic is a great sign to me. It shows there are places with a lot greater efficiency that are competing fiercely with the local source and are forcing specialization.

Services are not commodities: a service by one provider is not necessarily indistinguishable from another. Service providers, and producers in general, actually vigorously fight commoditization -- it creates an opportunity for a market, and this improves competitiveness and efficiency. The providers are comfortable with their high margin untradable goods, but consumers get high price variability and discover-ability. Since the service providers fully control the service, they are unlikely to ever allow a market to form.

Now imagine the opposite: imagine servers became fully commoditized. The market then would become highly specialized and efficient: you would probably be purchasing server time directly from the server manufacturer (chosen among many) through some contract and a provider (again chosen among many) would actually host the server and electricity for a cost. There's enough competition in the hosting business that this has essentially happened already: the commodity standard has become AWS. Low efficiency providers have been squeezed out for a long time.

It's hard to compare this to trading grains or iron, though.

The financial industry is 100% concerned with practical matters, since every stock is eventually linked to a real world property, value, good or service. It's a different matter if they are fair, though, as I discussed previously.

> Farming becoming economic is a great sign to me.

So will you go be a farmer?

The answer is no, because farmers are getting fucked. Consumers too - food inflation has been off-the-scale (and that money hasn't been going to farmers). Playing dice against PhDs with algorithms is a sure loss.

I don't think algorithmic trading itself is morally dubious. However the institutions, people's behaviour, artificial barriers to entry in the market and a lot of tangentially related matters are.

Your job sounds really interesting though! Are you at liberty to give a bit more details?

> Your job sounds really interesting though! Are you at liberty to give a bit more details?

I don't like to broadcast too publicly the details of where I work. Email me at jordigh@octave.org if you want more personal details.

From Wikipedia: "The first futures exchange market was the Dōjima Rice Exchange in Japan in the 1730s, to meet the needs of samurai who—being paid in rice, and after a series of bad harvests—needed a stable conversion to coin." Substitute gold, oil, stock, whatever for rice and the concept still applies.These are all things that need to be converted to coin in order for them to be of any use. Without traders, this would be extremely difficult, costly, and generally inefficient. With algorithmic traders it becomes even easier, cheaper, and generally more efficient.

I think there are 2 pieces to discuss.

1) Is alg trading overall a good thing? Possibly. It adds liquidity which helps ensure proper movement of money. Whether that is overall a good thing or not can be debated.

2) Is it a good thing to make a ton of money off of this? This is the question that is maybe a more obvious no. But you can apply the same logic to basically all of financial services. How much is too much?

I could defend the merits of algorithmic trading - having computers instead of humans price liquid securities has reduced spreads and the competition has brought down transaction costs overall. This all results in less and less of a chunk that "Wall Street" is taking out of "Main Street". And it results in a higher liquidity premium leading to higher share prices overall. This is good for companies and good for shareholders which include everyone with a mutual fund or pension.

But at the end of the day it doesn't really matter. People have traded for profit motives alone for hundreds of years without a social motive. Most of finance is conducted for profit alone. There are tons of businesses out there that are for profit alone. There's no need to look down on people for it.

Although normally algo trading is equated to high-frequency trading, there is - from what I understand - more to the term, including long-term investment.

And in general, the objective of a market is to allocate capital in the best possible way.

So, for that, I think that eventually an algorithm - or a market of algorithms - can get to be more fair and more efficient than a bunch of meat-based traders and investors. I'm pretty sure that we are not still there, but, assuming a future in which a huge, benevolent, fair capital allocation system exists, having people working on that might get to be morally good.

Excuse my possible ignorance, but I would assume that multifaceted algorithmic trading would work to flesh out corporate transparency, would it not? Given the assumption that nearly every aspect of a company could be used as some type of weight, I would think that a "lesser company" could be deeply impacted if it had even a single data point that could be questioned.

I'm hoping that this segment of trading will work to push us in more of the (relatively) transparent corporate model that's practiced by the technology leaders like AAPL, GOOG, etc.

It's no more or less morally dubious than targeted advertising.

You probably won't do good working for 90% of the companies.

I'm ok with that. I think it's worthwhile to a find job in the remaining 10%.

I find it too cynical to do evil just because everyone else is doing evil, although human psychology very much favours the herd mentality (broken window syndrome and so on).

Honestly, if you're interested in helping people with algorithmic trading, the startup I'm working on right now would be perfect for you. Although the pay won't be nearly as great as it would be if you were to work in a big firm, the opportunity to use algorithmic trading while not having to submerge your conscious is something I find more important and it's viable.

Algorithmic trading aids in price discovery which means better prices for buyers and sellers overall. Algorithmic techniques like statistical arbitrage help to even out cyclical or correlated market trends by exploiting them, and that means regular investors are more likely to get a better price at any given point in time.

Are there any empirical studies to back up this claim?

From the time of the telegraph traders and markets have always been trying to get an speed edge. This has never stopped and likely never will. The meaning of HFT changes with the times.

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