system two

system two
start-up thinking in the enterprise

Tuesday, 23 June 2009

Wobbly bridges, marching bands, traffic jams and 21st centruy marxism....vol.1

I've been working on a project for several years relating to  algorithmic trading - computer controlled hedge funds.

Much of my free time has been consumed by it. It has the potential to make money - but it also represents a contribution to the debate on how turbo-capitalism and the dogma of the free market are impacting our society.

By crunching a mind boggling amount of data (3 old PC's sitting in my office running macros pretty much constantly for 3 years) I am some way to demonstrating, that at certain times of the day, in liquid markets, you might need to do little more than place a trade in the prevailing direction of a market, and in aggregate, never lose.

Markets, like biological ecosystems, have participants - speculators and investors - who up until the beginning of the last decade, achieved a balance (of sorts) between their competing interests, based on limited liquidity and superior returns in other, non-equity investments.

After 2003 - the ecosystem began to become visibly disturbed (you can see it in the data). The phenomena of "algo" hedge funds exploded on the back of super cheap compute, cheaper money and dissatisfaction with post industrial, low growth, western markets. The effect on the FTSE has been considerable. At specific times of the day, hedge funds (speculators) now account for more than 70% of all trades.

My hypothesis is that these funds are now devoting so much capital to speculative trading they are beginning to create their own momentum. Momentum which at specific times of the day is disrupting random walk.

(this post was written before the phenomena of the flash crashes became common parlance http://en.wikipedia.org/wiki/2010_Flash_Crash)

To put it another way, aggregated behavior is leading to otherwise innocuous trends becoming magnified. It is the financial equivalent of armies failing to break step marching over a bridge - where hundreds of small steps, when made together, create a powerful momentum which can destroy the fabric of the structure on which they are impacting.

London knows a thing or two about wobbly bridges here. This article on the phenomena of traffic jams, with its identification of “"sonic points” also seems like a useful analogy.

Liberalisation of financial markets, an oversupply of money, the emergence of cloud computing and some very bright Phds could be starting to prevent markets working efficiently. The more participants who know about these specific time periods the worse, in theory, it’s likely to get. A small group of people discovering a casino always pays out on black at 11:45 doesn't stay small for long.

Could the market be dying in the digital age? Was the concept of a free exchange of risk, only a stable one in analogue times - checked by imperfect information and quasi-moral limits to speculation and greed? It is certainly interesting to ponder whether fewer asymmetries of information, which should lead to a more “perfect market”, have the opposite effect.

Imagine if this were true....

A world forced to re-adopt an inclusive, non-beggar my neighbour model for co-existence, not out of choice, but because the principle methodology of defining price – the market – was broken by digital technology and good old-fashioned human greed.

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