The Nature of the Modern Market

[jducoeur]

Those who are interested in real-world economics and finance may want to read this fascinating little article in Ars Technica. It's a brief look at how the stock market actually operates today, which bears little resemblance to how most of us *think* it works, or indeed how it worked only a few years ago. It focuses on the new High Frequency Trading platforms, the computer systems that allow Goldman Sachs and others to essentially game the market in a variety of ways.

It's not at all in-depth, but doesn't assume you know a huge amount about finance and such. So if you're curious about those record-breaking profits at Goldman last week, here's one of the elements feeding into that...

Comments

[goldsquare.livejournal.com]

The article says (at that back) and I emphasize in bold:

The other key ingredient to the success of any HFT platform is low network latency. The platforms are greatly helped in this regard by the fact that many exchanges will let HFT platforms pay to co-locate their servers with those of the exchange itself, so that the HFT platform can get its order in ahead of the competition. Critics contend that such co-location deals provide avenues for potential front-running of orders, in which an HFT platform gets an advance peek at an incoming order that will move a stock's price in a specific direction, and then uses that knowledge to make a quick bet on the impending price move.

The article fails to point out that front-running is quite illegal.

[goldsquare.livejournal.com]

Interesting article on why HFT is good for people. Does use some jargon that is non-obvious, but not bad.

It does have some "let them eat cake" mentality, but for all that, is illuminating.

[jducoeur]

Yaas -- it's pleasantly level-headed, admitting that there are abuses possible while pointing out that most usage is simply the market working as it's supposed to, just carried to a bit of an extreme.

Really, part of the issue is akin to class warfare: HFT amounts to a way to make money that the average person feels they have no access to. (Made worse by the fact that the company being "blamed" for it has been a bit too close to the heart of the financial meltdown, so it looks to the average person like the bad guys making out like bandits.) Hence, it's unsurprising that the issue has gotten a bit over-hyped, with the problems particularly emphasized...

[goldsquare.livejournal.com]

Been reflecting on that article and others. I am still of the belief that profit should be related in some way to productivity, in a situation that provides some benefit or hope of benefit to both sides.

In that case, HFT is likely just profiteering. Not productive at all. Unless it is lowering the cost of trading for others, which I think is not clear at all.

[goldsquare.livejournal.com]

PS, more or less on the same topic, this article is hysterical.

[goldsquare.livejournal.com]

More link goodness from New York Times.

[jducoeur]

Deliciously funny! Thanks for the link...

[jducoeur]

While that's a reasonable view, finance is pretty deeply intertwined with capitalism, and it's not clear to me that it can be extricated. And there is some benefit from it, in that (when working properly) it helps the rest of the economy run.

Unfortunately, when it gets carried to ridiculous extremes (as it does from time to time, always in new and different ways) it becomes less beneficial and more an activity unto itself. But as always, legislating against the abuses while leaving the benefits in place is tricky -- the line where it becomes pure "profiteering" is usually pretty subjective...

[goldsquare.livejournal.com]

You are right, but my comments were sort of vaguely related to a wacky theory I have about the shrinking US economy and why. Part of that is sort of an analogy to two guys on a desert island - instead of trading skills back and forth ("I can build a hut, you can make food") they are trading a coconut back and forth for shells - every now and then declaring "bankruptcy" and getting a fresh coconut.

HFT is some guy who keep stealing the biggest shells and replacing them with smaller ones. :-)

But as I said, the analogy is ill-formed.

[jducoeur]

The other thing I'd bear in mind is that there's nothing especially new in *kind* about all of this: financial bubbles and abuse are as old as the country, and it's very easy (and traditional) each time the bubble seriously pops to believe that something has gone particularly wrong. In practice, it's all horribly ordinary. (We tend to forget that, prior to the Great Depression, there were a bunch of severe finance-driven recessions.)

Also, I'm skeptical about "the shrinking US economy". Rather, my suspicion is that it simply never was as big as we let ourselves believe 3 years ago. Much of the supposed money was really a finance-driven illusion, and the real problem is simply that it got too intertwined into the "real" economy. I think there was a lot of real growth, but also a fair amount of fake growth. (Not least because of the utter insanity of the CDS market.)

All that said, it's certainly possible that HFT, by making it possible to actually reach reductio ad absurdam on some financial practices, is shifting the landscape a little. The above should mostly just be taken as a caution to remember that it's hard to have historical perspective when we're in the middle of one of these upheavals...

[goldsquare.livejournal.com]

I think you are largely right, but commenting on the margins:
Also, I'm skeptical about "the shrinking US economy". Rather, my suspicion is that it simply never was as big as we let ourselves believe 3 years ago.

That's sort of the core of my ill-formed thought. The "economy" was large, because the economy is how much money changes hands. The "value" behind that, was much as you say, much smaller.

I'm also thinking about how we let inflationary monetary pressures get out of hand, by permitting super-leveraging of banks. 40:1? Oh my. As one blog put it, at 40:1 leverage, if you lose 3.3%, you have wiped out all the capital your business ever owned. If one follows that logic closely, say a business can only afford to lose 10% of their actual liquidity. At 40:1 leverage, that means that any epsilon loss in trading or speculation puts them in the poor house.

[jducoeur]

The article pretty studiously avoids getting into what is and isn't legal; rather, it's trying to give a fairly value-neutral idea of What's Going On. I think that's useful -- by being so careful to avoid shrillness, I suspect it is likely to get more people to read it seriously and understand the facts. (Which can *then* be used to emphasize that this sort of gaming of the system is illegal, and for good reason...)