Is the Singularity already happening at Goldman Sachs?

Singularity Goldman Sachs

"Nearly everyone on Wall Street is wondering how hedge funds and large banks like Goldman Sachs are making so much money so soon after the financial system nearly collapsed," writes the New York Times’ Charles Duhigg in a front page piece that’s been the talk of the town in New York and Washington. "High-frequency trading is one answer." Duhigg writes, “High-frequency trading systems are so fast they can outsmart or outrun other investors, humans and computers alike."

The term “high-frequency” refers to fast entry and exit of trading positions, the process best executed by algorithms and dedicated computer programs employing artificial intelligence. However, this can turn into the intentional probing of the market with tiny orders that are immediately canceled at speeds that cannot be matched by individual human investors.

While this isn’t quite the "intelligence explosion" of machines foreseen by I.J. Good in 1965 and dubbed “the Singularity” by Vernor Vinge in 1993, the speed and sophistication of Goldman Sachs computer algorithms are indeed leaving humans –- at least, individual investors –- in the dust.

Investment Manager Irene Aldridge sees high frequency trading as having a bright future that is “bound to bring additional skill and capital” to markets. She points to Tabb Group estimates that high frequency trading (HFT) accounts for 73% of equities trading volume on U.S. exchanges. Aldridge: “HFT is characterized by fast turnover of capital. Instead of capturing large price changes over extended periods of time, HFT aims to book multiple small gains over short periods of time.”

Joe Saluzzi, Partner at Themis Trading, sees it differently. He bemoans the institutional use of co-located high-bandwidth supercomputers near the trading floor, “We are just mice dancing between the elephants of capital and their supercomputers. Just this past week, we found out that hedge funds have passed mutual funds in terms of volume of equity trading, despite controlling far less money.”

This video shows the intensity of the debate over HFT, with Joe Saluzzi expressing mock surprise that he isn’t debating a supercomputer (shades of Kubrick’s HAL 9000):

There are several possibilities about what’s going on here. One is that Goldman and others are literally using privileged information to make trades ahead of markets, in which case they are committing a felony. Specifically, this is known as "front-running," or trading ahead of customers, and it is an explicitly illegal form of market manipulation.

Another possibility –- mentioned by Robert Kuttner in a recent Huffington Post article –- is that “the Goldmans of the world” have found themselves a nice loophole. Tapping into the Stock Exchange’s own computers and other sources of trading activity is something that anyone in theory could do, but only a few privileged insiders have the sophistication to exploit what they find.

Stock ExchangeDuhigg’s New York Times article illustrates a case in point. Intel, the computer chip giant –- reporting robust earnings –-triggered some individual human investors to buy shares in the semiconductor company Broadcom, “The slower traders faced a quandary: If they sought to buy a large number of shares at once, they would tip their hand and risk driving up Broadcom’s price. So, as is often the case on Wall Street, they divided their orders into dozens of small batches, hoping to cover their tracks. One second after the market opened, shares of Broadcom started changing hands at $26.20.”

The slower traders began issuing buy orders. But rather than being shown to all potential sellers at the same time, some of those orders were most likely routed to “a collection of high-frequency traders for just 30 milliseconds — 0.03 seconds — in what are known as flash orders.” In just this fraction of a second, high-frequency traders determined that the market for Broadcom was growing. Their supercomputers began buying up Broadcom shares and then reselling them to the slower investors at higher prices. The overall price of Broadcom began to rise, “The slower-moving investors paid $1.4 million for about 56,000 shares, or $7,800 more than if they had been able to move as quickly as the high-frequency traders.”

Supercomputers began buying up Broadcom shares and then reselling them to the slower investors at higher prices. The overall price of Broadcom began to rise

Was the actual advantage the speed of the supercomputers? Nasdaq OMX Group Inc., Bats Exchange Inc. and Direct Edge Holdings Inc. hold these orders for milliseconds, giving their paying customers the opportunity to gauge demand before traders on other exchanges get the chance to bid. While the ethics and legality of this are debatable, Senator Charles Schumer has asked the U.S. Securities and Exchange Commission to ban such “flash orders,” saying the transactions give high-speed traders an unfair advantage over other investors.

Wall Street

“Flash orders allow certain members of these exchanges to obtain access to order flow information before that information is made available to the public,” writes Schumer. This allows “those members to use rapid trading programs to trade ahead of those orders and profit from advanced knowledge of buying and selling activity.”

Regardless of the debate over how HFT is used in market trading, it’s clear that supercomputers can already “outrun and outsmart” individual investors. This isn’t quite the Singularity envisioned by Good and Vinge, but it raises some perplexing questions about the use of artificial intelligence to gain market advantage when individual humans “with slide rules” cannot compete.

QUESTION FOR READERS: Are "flash orders" unethical and should they be banned?
(POST YOUR COMMENT BELOW!)

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13 Responses

  1. Anonymous says:

    no, that can not be satisfying
    as a technical perspective of being a computer scientist
    how many of you study dynamical system, statistical mechanics or quantitative finance, 20 more variables do not make you too much outperform the market, growing from 40-60, that is what we called asympotically logorithmic improvement for singularity to materialize, also the computer today do not set variables on themselves
    also, there are lots of human insights required to deal with human insight, even in the short run, like weekly, daily or even hourly,
    faster computer make you plan in higher granularity, but a coarsely grained but strategically sound and flexible human insight can easily outweigh that, today’s bank struggle to make limited money a low one percentage level, 1 percent higher trading in foreign exchange market CAN MAKE THE MONEY OF THE WHOLE WORLD TO ANY INDIVIDUAL PREDICTING SLIGHTLY MORE ACCURATE, 1 PERCENT IS CALLED SIGNIFICANTLY MORE ACCURATE!!!!!!!!!!!!!!!!!!!!!!

  2. maguro_01 says:

    What percentages of shares are, shall we say, in the custody of HFT/the market and hedge funds at any given time? What does this mean to corporate governance?

    How many shares are in the hands of funds making money either way? That is, how much of the market has no interest in the success or failure of a company, but only an interest in exploitable volatility? What does that mean to corporate governance?

    Are there any virtual companies yet? That is, that only exist as entities in cyberspace surrounded by instruments that make money both ways? Have any former actual companies become virtual in recent years? I have no objection to this so long as the officers and directors are virtual and, as the technology develops, the traders as well…

  3. William Largent says:

    Foreshadowing anyone? It’s been bout a year since this article was written, discussing the dangers of high-frequency stock trading, and yet we still had one of the worst single-day crashes in history because of it, one which we are still feeling the affects of. The government should have been pushing for a ban on high-frequency trading for years, because it clearly (and did) only lead to more harm than good. Simply put, a stock market cannot operate appropriately if it is not in the hands of human beings, and those pieces of electronics that assist us in our tasks. There is a certain equilibrium at work, one that is very fragile and in turn extremely dangerous if it is disrupted. There needs to be a proper proportion of loss to gain and gain to loss. Thank you for citing these articles, too bad no one listened!

  4. Anonymous says:

    I agree with Irene. I’d definitely go for a long trade on her pips.

  5. j2d2 says:

    The author clearly has not done his research or he’d know the front-running “felony” is actually a service offered by the NYSE and is currently under investigation by the SEC as to whether it should be made illegal. It is currently quite legal and you can buy the service yourself today.

    It makes the rest of the article a little hard to swallow. Chock full of hyperbole.

  6. Surfdaddy says:

    If you’re referring to HFT as a service, then you probably didn’t read the entire article. HFT certainly isn’t illegal, but its application in "flash trading" may be a new form of front running. That is the point of the article and the video, to characterize the debate over this. While it’s true that front-running isn’t always illegal, it is illegal for brokers or asset managers to practice front-running using trading information about their own or another broker’s clients, and this is regulated by the SEC. Irene acknowledges this in the video. The most common example of front-running is when an individual trader buys shares of a stock just before a large institutional order for the stock which will cause a rapid increase in the stock’s price.

  7. Olive Farmer says:

    The devil is in the detail, as ever.
    What these people are doing is skimming wealth created by human beings.
    Everyone works harder to support this thieving gang of usurious swine.
    If you ever wonder where the “free time” we were all supposed to have by now, start with the global banking criminals and their puppet governments.
    They are spending YOUR free time.
    http://www.olivefarmercrete.blogspot.com

  8. Jim Lai says:

    No numbers cited, but there’s a claim that flash orders are more common with options exchanges than with equities.
    http://online.wsj.com/article/SB125011050709126957.html

    Things get interesting when flash trading interacts with dark liquidity. The result is a combined market that is increasingly opaque to non-institutional traders.
    http://online.wsj.com/article/SB124906083065697257.html

  9. invester central says:

    Survival of the fittest has now become the survival of the fastest and
    Yes- this should be ILLEGAL.

    a select few who have technologically advanced systems have profited off the slower investor w/o the advanced technology. Buying in at high speed rates and then dumping the stock to interested investors when the stock is on the rise.

  10. boomhauer says:

    does anyone even remember what the stock market is supposed to be? an easier way to be a business owner instead of starting your own company. think about it. what does it even mean to own a stock for 30 milliseconds? it’s all so stupid.

  11. boomhauer says:

    And also… if this AI is successfull in continuously skimming wealth from the market, it will eventually own everything. That, or the humans it competes against will just stop playing the game.
    Hell let’s require a stock holder own any purchased share for a month. Take it back to what business ownership was meant to be. Literally anything else is just skimming wealth from the producers to a bunch of nonproducer banking idiots with computers. Explain to me how they are contributing anything for the wealth they remove from the market?

  12. Jim Lai says:

    This piece on high frequency trading ends off as if it’s responding to the above article. The author is against flash trading, which he claims predated HFT.
    http://www.iimagazine.com/rss/Articles/2294885/The-Truth-About-High-Frequency-Trading.html
    “I only hope that regulators seek facts and objective reality, rather than succumb to the sort of wild fears that bring to mind films like The Terminator or The Matrix. There is no robot revolution looming, and the machines still have off switches. “

  13. Alios Shicklegruber says:

    Amen

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