The Early Days of a Better Nation

Wednesday, January 23, 2008

Bon mot du jour

From the reliably snarky IOZ:

"I love the smell of market corrections in the morning. It smells like victory."

In that post's comments, a link to an interview with a hedge funds manager:
HFM: You build the models and the computer does the trading. You actually do all the analysis. But it’s too many stocks for a human brain to handle, so it’s really just guys with a lot of physics and hardcore statistics backgrounds who come up with ideas about models that might lead to excess return and then they test them and then basically all these models get incorporated into a bigger system that trades stocks in an automated way.

n+1: So the computers are running the…

HFM: Yeah, the computer is sending out the orders and doing the trading.

n+1: It’s just a couple steps from that to the computers enslaving—

HFM: Yes, but I for one welcome our computer trading masters.

People actually call it “black box trading,” because sometimes you don’t even know why the black box is doing what it’s doing, because the whole idea is that if you could, you should be doing it yourself. But it’s something that’s done on such a big scale, a universe of several thousand stocks, that a human brain can’t do it in real time. The problem is that the DNA of a lot of these models is very, very similar, it’s like an ecosystem with no biodiversity because most of the people who do stat-arb can trace their lineage, their intellectual lineage, back to four or five guys who really started the whole black box trading discipline in the ’70s and ’80s. And what happened is, in August, a few of these funds that have big black box trading books suffered losses in other businesses and they decided to reduce risk, so they basically dialed down the black box system. So the black box system started unwinding its positions, and every black box is so similar that everybody was kind of long the same stocks and short the same stocks. So when one fund starts selling off its longs and buying back its shorts, that causes losses for the next black box and the people who run that black box say, “Oh gosh! I’m losing a lot more money than I thought I could. My risk model is no longer relevant; let me turn down my black box.” And basically what you had was an avalanche where everybody’s black box is being shut off, causing incredibly bizarre behavior in the market.

I love the smell of brains exploding in the morning. It smells like victory.


I'm possibly too close to bedtime to be posting, but anyway...

Isn't this rather like the 1987 crash, or was it some other date, when all the fancy computer models failed because their limits were exceeded, and they basically drove the stock market down much further than it would have gone had humans been doing it?

Also, doesn't this also show the silliness of trying to predict and play games in such a complex manner?

It feels like a parody of the Turing test - the tipping point at which an AI can adequately replicate the stupidity of the human herd.

Somebody please let me bet against capitalism.

Jesus H. Christ on a bike... Do you ever fear that maybe your books are too close to the mark, Mr. MacLeod?

If you are interested in where algo-trading is going check this out:

Reuters NewsScope Sentiment Engine:

Reuters NewsScope Sentiment Engine (RNSE) processes a stream of Reuters English language news items, producing sentiment data for a list of customer determined target companies. Scores consist of how positive, negative, or neutral a particular article, or substantive entity within an article, is written by the author.

The RNSE can score many articles per second making it applicable to real time algorithmic trading as well as a host of other use cases. Firms engaged in programmatic trading who want to send a buy or sell signal to trading applications based on positive or negative news scoring would benefit from using RNSE.

Steven, I don't think I quite got robot trades in anywhere. It's all more like a Charles Stross novel, or one of his short stories where AI emerges and EATS OUR BRAINS.

This story could be even more interesting if you suppose that since SocGen's actions in unwinding Kerviel's dodgy positions resulted in about €70bn worth of seriously loss making trades (for them) on Monday during which the €5bn loss was presumably realized. So those highly visible loss making major trades trigger the automated bots to go into a bad feedback loop because this is certainly a situation the weren't designed to deal with thus creating Monday last's market melt down. If this is true then the Fed's knee jerk response on Tuesday is even more crack headed than it otherwise seems. Surely though the international financial system can't be that fragile?

I a world where the people spending money don't really have any, the collapses shouldn't be automatically blamed on computers. Rather, it should be "blamed" on the guys actually owning the money waking up from the smell of coffee and burnt dollar bills.

I didn't know this. so you actually mean that the stock market is run by some software? then what are the real people there for, with their huge bonuses? I admit I don't understand anything on the issue.

anyway, I like your blog and just given you a link. visit mine and see if you want to reciprocate. ciao! :)

Maybe no robot trades, but wasn't the ANR's AI general a piece of economic planning software?

Steven - yes, so it is. Maybe if the guys at Reality can smuggle their socialist planning algorithm into one of these black boxes ...

LOL, yeah; who knows, maybe they have. Maybe that's what's driving the recent downward spike in stock-values is all about.

Hey... You never know! =)

Ow... That's painful syntax. I apologize for subjecting you to that.

Let's see ...

Pension funds all over the planet have looked for somewhere to dump their huge loads of money.

Chinese businesses have looked for somewhere to dump their huge loads of money.

Some big takers of the surplus investables have been USans with no large ambition or ability to pay back.

The central banks of various countries have held interest rates low and money printing high, thus making money something to loan for quick spending, and also something in oversupply ...

Sums up to what?

= = =

An interesting source suggested that gold has never gone up in value, but that --being the only currency not subject to government fiat-- it has been the only currency whose value has remained unchanged. Even the central banks' massive dumping of gold from their vaults has done little to make it follow the government fiat currencies down.

= = =

Well, just a perspective.

Incidentally, any proper gambler would know that if you bet large sums of money in order to win very small sums, which is what was happening at SocGen and presumably everywhere else, then you are doing something that will always end in disaster because even though you may have a very good system, the problems that might cause it to unwind are unlikely but not impossible. So sooner or later they will happen and then what happens is that you've got a vast sum of money invested in bets and you can't get it back.

Gambling buffs will have heard of the "foolproof" Labouchère system (the rest of you can look it up) and basically what SocGen were doing was something very similar. Huge sums, to win small sums. Trousers round ankles and arses swinging in the breeze.

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