Thursday, April 21, 2011

Meet Robo Trader

"I'm sorry, Dave. I'm afraid I can't do that." ~ HAL9000

My wife and I often listen to National Public Radio news as we sip our morning coffee in bed (one of the more lovely benefits of retirement). Often during the broadcast, punctuated in between the news stories, the reporters usually toss out a brief update about how the Stock Market is doing. The Dow is up x points, or the NASDAQ down by y. I often wonder, what is the point of telling me this information? In a matter of minutes those markets can completely reverse.

Worse yet is when the news then attempts to explain WHY the Stock Market took a particular rise or fall. Recently the market apparently fell on worries about the nuclear plant disaster in Japan. Oh really - how do they KNOW that was the cause? A few years back I heard a reporter attribute the market closing lower because President George Bush was having his colonoscopy. What the... ?!

The truth is that I don’t think anyone has the remotest clue why the Stock Market trends as it does. The media obviously pulls some current story out of the blue and attempts to attribute cause-and-effect to these fluctuations where there is none. Humans naturally expect reasons for why things happen, therefor, a causal effect is simply manufactured that has absolutely nothing to do with reality.

I became even more dubious about Stock Market trends after discovering that a huge majority of the trades executed daily are no longer done by human traders but by computers. The number of human traders on the floor of the stock exchanges has actually dropped by a large percentage.

As it turns out, a significant number of the buy/sell trade decisions are not being made by human traders - To a significant degree computers have taken over the buying and selling of stocks. I recently watched this story on the TV news show, “60-Minutes”. Companies have now invested millions in computer hardware and algorithms which can spot and act on trends within microseconds. Traders on the floor of the Stock Exchange is now old school.
Excerpt: It may surprise you to learn that most of the stock trades in the U.S. are no longer being made by human beings, but by robot computers capable of buying and selling thousands of different securities in the time it takes you to blink an eye.

Today [the floor of the New York Stock Exchange] is still the public fa├žade 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 are being replaced by the speed and quiet efficiency of computers and the action has moved elsewhere. 1.
For me this has significant bearing on the entire purpose of the Stock Market. Companies used to offer investment in the form of stocks to raise capital in order to expand, grow and become profitable; thereby sharing the benefit through dividends to their investors. However in recent years I have been puzzled why it seemed the stock in one company would fall even when they reported profitable years; equally puzzling were the rises in stock prices of companies obviously languishing.

Now I understand why – the decisions regarding the sale and purchase of a company’s stock have no bearing whatsoever on the viability, market potential or management of that company. Those buy/sell decisions are made within fractions of a second by automated traders who may likely hold a company stock it just purchased for only three minutes before it sells it.

The people behind this trend say this should have no negative effect on the small investors who like to play the stock market using their best analytical considerations about the viability of the companies they choose invest in. But if the prices are actually driven by the mindless millisecond musings of a super computer, how can you be sure the small investor is safe?

This one thing I do know, as NPR tells me the Stock Market is up or down so many points, by the time I finish my morning coffee, that information is old news.
1. How Speed Traders Are Changing Wall Street, “60-Minutes”, October 10, 2010


Paul said...

Who knows what to believe Robert ?

DJan said...

I have been interested in the market numbers ever since I retired, but I'm really not sure why, since as you say, they go up and down for mysterious reasons. Perhaps I've been conditioned to pay attention to those numbers.

Robert the Skeptic said...

Paul I'm finding it necessary to reexamine long-held assumptions.

DJan I had thought that the condition of the stock market reflected the overall of the economy in general. But it appears to me there is little connection - hence the wealthiest 2% continue to see huge gains in the value of their assets while the middle class languishes in stagnant wages and little hope of recovery.

Jon said...

I always figured the stock market was just a casino for the wealthy. Recent years have reinforced that belief.

wv: tinat: what a cockney sees on my head.

adrielleroyale said...

The hell if it doesn't affect the small investors! What a crock. This seems to be one more thing that needs to go back to the dark ages... or something..

KleinsteMotte said...

Have you read the article on artificial intelligence in Wired magazine? It was in their January addition. What is more worrisome to me is that humans input information into the system that can mess with it and that has happened. There are people sitting at there computers trying to be faster than others at inputing and then making gains. They go through markets that are open around the world and that operate with no time delay. Though risky they seem to love the thrill enough to do it. There are groups set up just for that and all sorts of places where they hide or access funds in an instant. And it is not good because it is not monitored properly. Once again organized crime have found a place that is so crafty our system will likely not be able to fix the mess.We just keep losing more and more.

Anonymous said...

I guess that leaves the big question-what variables are being programmed into the algorithms? I doubt that they are based on W's colonoscopy, for example, and I wonder who or what is entering the information being "considered" by the computer.

We down-home folks are being played in so many ways. "Wag the Dog" keeps coming to mind.

The Mother said...

"The people behind this trend say this should have no negative effect on the small investors who like to play the stock market using their best analytical considerations about the viability of the companies they choose invest in."

Yeah. Bullshit.

Antares Cryptos said...

Stocks are like gambling, the house always wins.

I was really surprised when I found out that people in that industry don't invest in it, but art and properties instead.

If someone ever figures out a mathematical theorem to predict markets, wonder what would happen.

Buz said...

To me it seems every market crash is just a ploy intended to increase the gap between the rich and the poor. Prices plummet, the fearful and desperate start selling everything at exactly the wrong time, and the grinning rich just start sucking everything up.

Or maybe I've just had too much wine to drink tonight.

billy pilgrim said...

i think the last 20 years have been an excellent time to invest in the markets. commissions are dirt cheap and if you don't want to do any research you can select an etf that has rock bottom management fees compared to the ridiculously priced mutual funds.

the daily gyrations of the market are nothing but noise and should be ignored.

the low commissions charged by discount brokers may have played a role in the financial meltdown as the bond market became the big money maker for brokerage houses and when sub prime loans morphed into investment grade bonds the seed was sewn for a market collapse.

so it goes.

Paul said...

The economy She is sick Robert...I predict double dip and soon...

Robert the Skeptic said...

Jon The market, like gambling, is unpredictable. But unlike gambling where at least the mathematical odds of winning are generally known, the stock market as it is now, appears to be directly manipulated.

Adrielle Well I would think it HAS to affect small investors, how could it not? Small investors cannot analyze trends in a microsecond.

KleinsteMotte I haven't seen the article of which you speak, but I am following the AI trends closely. The lack of monitoring is worrisome to me. They say there are "safety valves", safeguards where rapid and deep declines are stopped automatically. But what damage is done before the safeguard kicks in?

Robert the Skeptic said...

BackRow As I tried to point out, the media tries to find some sort of correlation to explain the movements of the market. It's wishful thinking. The algorithms are closely guarded secrets - it's proved there is a place for mathematicians on Wall Street.

Dr. Mom I agree, how can the small investor successfully compete against essentially computer trading. The big winners are the companies like E-Trade and other discount brokers who individuals can sign up with. Gain or loss, they make money on each trade through commission, yet another example of "mining the Miners", there is where the money is.

Cryptos Donald Trump made his billion almost exclusively in real estate. Essentially these algorithms are programmed to do just that, predict the market trend over a very brief (minutes) period of time.

Robert the Skeptic said...

Buz Indeed, many unsophisticated investors do not know when to "time" their entry and exit from the markets. Generally they end up losing money. I actually played this game during the Tech Boom, and we did come out ahead... though we would have done a lot better had I known when to get out. I delayed and so my gains were lessened to some degree.

Billy Exactly, the people selling "access" to the markets are always the winners, they get paid regardless of whether the investment loses or gains. But even people who had invested in mutual funds have taken it on the chin. One of our friends has lost half her retirement investment in the meltdown last year

Paul Robert Reich believes we are headed for a second dip as well as others. I fully agree. The Conservatives will NOT ALLOW the economy to improve during Obama's administration and will stop at nothing to ensure that happens. They, of course, will project themselves as our saviors in 2012... and the public will buy it hook, line and sinker.

Nance said...

You are singin' my song here! After the stock market ate my future for the fun of it, I began to realize that listed companies based in America for the tax structure, but operating largely outside of America for the profitability, are not tied to our economy and don't reflect America. And the financial industry has its very own country in some parallel universe where accountability is not a word.

As for double dip, as far as Main Street is concerned, we never undipped the first time. The stock market is not the economy and vice versa.

Sightings said...

Hi, I like your analysis, except I think the computers are more like Watson than HAL. The computers are smarter than we are, and will probably make more money than we do. But that doesn't mean we can't make any money at all.

I agree with Jon that playing the stock market is kind of like playing at a casino. But here's the difference. The casino pays out 95% of every dollar played. The stock market pays 105% of every dollar played. It's still a gamble, but with better odds than Vegas, or your bookie -- which is one reason why people who play the stock market tend to be richer than people who bet with a bookie.

Btw, love your photo!

Snowbrush said...

"what is the point of telling me this information? In a matter of minutes those markets can completely reverse."

And often do, but, still, I take a certain comfort in knowing that it's down 100, for example, as opposed to being down 1,000. That said, if I'm planning to buy into our IRAs, I actually try to pick those days when it's down a thousand at 3:00 (Eastern time) because it rarely comes back from that big a decline in the space of an hour, and since i can only buy in big increments, I sure as heck rather do it on a down day than an up day. Of course, it could just keep going down tomorrow, but one can't see the future, and like you suggested, NOBODY is worth a darn at consistently predicting short-term movements.

Robert the Skeptic said...

Nance Actually many of those companies have moved their corporate headquarters (on paper) to countries with lower corporate tax rates like Switzerland. They maintain an office "front" there, it's a total tax dodge. I scratch my head when I see our economy languishing, jobs disappearing, and the stock market soaring - there is some major disconnect here.

Sightings The computers running these programs are indeed more like "Watson".

The few times I have been with my wife in Las Vegas, she has looked around at all the opulence and quipped: "Think about it, all this was built by losers."

Snowbrush I tried that as well for a brief time, investing when the market was "down"... only to have it drop further. It seems no more predictable than a coin toss to me.

KleinsteMotte said...

Robert the article is available on line at Wired. It mentions what has happened when the safety valves did not kick in and it has happened.

KleinsteMotte said...

While there seems to be a drop in jobs and income in N.A., have you checked the growth rate of middle class India and the way they are buying gold? The Chinese are having huge growth in their middle class too. And they are making huge demands on the market. They have purchasing power that appeals to the big corps.

secret agent woman said...

My approach is to keep my money mostly in mutual funds (stocks and bonds) and then willfully ignore Wall Street News. Otherwise I'd go right out of my mind.

GutsyWriter said...

I agree with what you say except for the fact that the dollar, as you know, is no longer regarded as it used to be. Major changes are happening and when we heard of the AAA bond credit rating being devalued, this obviously cause the stock market to plunge.

Robert the Skeptic said...

KleinsteMotte The "safety valve"... well people manually shut down if it goes bonkers, which it has a couple of times.

China and India are becoming the new consumer classes, they want what we in the West have enjoyed all these. The problem is there are not enough resources to bring the entire planet into the middle class. But true, American businesses really don't care if we have jobs (and therefore consumers) in this country as they see their markets now outside their borders.

SecretAgent Hopefully you get reports where you can see what your mutual funds are doing. My trust in professional managers has eroded significantly; we have friends who had supposedly top-notch asset managers, now half their asset is completely gone.

Gutsy I have heard that in the news as well, that the Dollar may not continue to be the world currency, the Yuan is being proposed.

Rain said...

You said it well. If the ordinary person has made sure their stocks are in companies with solid products, they are less impacted by these swings. If they don't sell instantly, that also helps. The problem is most people are in IRAs or something that is managed, as you said, by those computers. Scary that it's what they base the strength of our economy on :(

Antares Cryptos said...

Very interesting conversation here.

P.S. Robert, have you seen this?

Robert the Skeptic said...

Rain My fear is that people will not monitor who is "managing" their IRAs. I think the financial sector is turning into the Wild West here.

Cryptos That video was almost as banal as the AARP rags they send us every month. Viva recycling!!

Marylinn Kelly said...

Where can we put our trust? What is the truth and who has the time and energy to try and root it out? Such revelations - robot traders - no longer surprise me and I wish that were otherwise.