Friday, August 17, 2012
Only 23% of Greeks want a return to the Drachma
Ask Greek Citizens About Soft (Drachma) Money, And If They Like It
Throughout the past hundred and fifty years or so, especially in U.S. politics, a manipulated currency (“soft money”) was favored by left-leaning interests, in practice the Democratic Party. A gold-standard system (“sound money” or “stable money” or “hard money”) was favored by right-leaning interests and the Republican Party... http://www.forbes.com/sites/nathanlewis/2012/08/16/ask-greek-citizens-about-soft-drachma-money-and-if-they-like-it/print/
Thursday, August 16, 2012
Expert Advisor Development
Building forex trading systems is the reason that this company
exists. Nearly every one of our clients aspires to be a fully automated
trader.
The percentage of clients that succeed over the long run, however, is incredibly small. I don't think that is a big secret. If that is news to you, allow me to be clear. The chances of developing a successful expert advisor over the long term are minimal.
The inevitable next question from new clients is an attempt to pick my brain for some features common to successful systems traders. I decided to outline the traits common to this rare breed and some of the challenges that they encounter.
That's my theory for why the "intellectually challenged" crowd seems disproportionately likely to profit from trading. They see right through the noise to pick out a simple observation that wins more than it loses. Holy grail systems certainly do not come from this group. That's not honestly not the goal. It's about eating cheese more often than going hungry.
The brainy crowd benefits from a heavy dependence on analysis. Ideas usually stem from pet theories, many of which look like the crackpot variety on first glance. The theory shifts and twists as market tests reveal strengths and weaknesses. Logical conclusions instill a robustness and variety into the system. Interestingly, the approach to testing and verifying the systems follows the opposite path of most developers. The ideas tend to get simpler with time rather than more complex.
Emotion does not play a large role in the rationale for developing an expert advisor. Again, the reasons are usually logical. Examples like "I've been trading this system for 20 years and I need to automate it" or "I came up with a way to accurately predict market direction."
It may sound a bit zen, but the systems that make money are the ones that do not set their primary goals as making money. Making money is a totally open ended goal. The potential variables know no limit. The lack of constraint encourages would be EA traders to shoot off on tangents. Unless the wild ride accidentally leads to the pot of gold at the end of the rainbow, they will fail. The limitless bounds make it impossible to measure any progress.
In that same vein, the journey is as important as the destination. Many traders pay lip service to limiting drawdown. Few are able to effectively rein in drawdown, especially within the context of an expert advisor. To a certain extent, limiting drawdown is not possible. My experience with money management makes it clear how much wandering a return can make, even with a heavy advantage.
The easiest way to limit drawdowns is to fight against severe losses. The goal is to obsess over risk and reduce it to the lowest possible point. I want to emphasize this point carefully. Risk always exists. The market chaotically switches from deep slumber to extreme violence. No amount of system engineering eliminates or alters the structure of the market. The most effective way to handle risk that I see is not to prevent it from happening (not possible), but rather how to react when risk eventually flares up.
Approaching system design as a process rather than a destination also encourages global thinking. My old boss would describe it as the 40,000 foot perspective. When a forex trader, for example, emphasizes a system's percent accuracy, it typically comes at the expense of exiting at a better point in the market. A need to win slightly more often actually drags the system away from its optimal performance. A process oriented design watches how changes in the entry method affects the exit efficiency. Clever money management removes the emphasis from entry and exit methods.
Designing these systems takes hundreds of man hours or results from more than a decade of experience. Emotion will certainly enter the equation at some point. The real question is not how to remove it. It is how to appropriately channel it.
Designing an expert advisor quickly takes on the characteristic of an obsessive hobby. If the system's success is measured in quantities of dollars, the emotional roller coaster rises in tune with the account balance. A more appropriate use for the emotion is to take heart in the system working correctly, not profitably. Ideally, correctly also means profitably. They are not the same thing, however. Drawdown and unlucky losing streaks are an inherent part of trading. Gaining satisfaction from the trade behaving as designed rather than as desired makes your emotional well being far less dependent on market performance.
I have been running this company for nearly five years and literally spoken with thousands of traders over that time. In spite of that overwhelming number, I still have yet to speak with anyone that traded a commercial EA successfully for more than a few months.
The successful traders that I know personally all developed their systems and strategies on their own. Maybe that reflects on the abysmal quality of expert advisors for sale on the internet. Maybe it reflects on not-so-expert trading coaches, or perhaps genuine trading coaches and hapless traders unable to follow sound advice. I suspect it's a little of everything. Regardless of the problems, the take away point is that the person doing the succeeding is also the person doing the developing. They take control of the experience from the beginning and lead it into a successful outcome. Systems trading is not a process where you buy your way to success or follow like a sheep to green pasture. You must earn it.
That kind of trajectory puts a number in the trader's mind that is terribly misleading in real life. Steady annual growth of 20% suggests a constant return of 1.67% (20/12). That number 1.67% is a hiccup in a trading account. Many forex traders risk more than that amount on a single transaction. Factoring in the inevitable drawdown or periods of loss, the market makes it impossible to distinguish whether or not the expert advisor is behaving correctly or if it is falling apart.
Uncertainty in the face of risk makes any normal person panic. At the very least, it instills a degree of anxiety over the future. The moment that the machine stops churning out profits is the moment where doubt enters the picture. Doubt feeds on itself, which leads to changing the trading plan in midstream.
I can tell you from experience that the transition from research to execution is huge. A learning curve exists, like with everything. I learn to cope by taking the confidence that I gain through the same debugging techniques used in testing. The same techniques work for comparing live results to backtested results. Does the backtest over the same time period as my real trading match the actual performance? If so, then all is well. If not, it at least gives me as the developer an opportunity to think about specific problems. Execution or forex broker manipulation can cause problems. More often that not, however, is some flaw in the strategy design or code. Developing a methodical, reason based process helps calm nerves and to stay focused. The alternative is a general, undefined worry.
The percentage of clients that succeed over the long run, however, is incredibly small. I don't think that is a big secret. If that is news to you, allow me to be clear. The chances of developing a successful expert advisor over the long term are minimal.
The inevitable next question from new clients is an attempt to pick my brain for some features common to successful systems traders. I decided to outline the traits common to this rare breed and some of the challenges that they encounter.
Traits of a successful EA developer
Expert advisor developers that succeed are either incredibly bright (engineers, Ph.D. holders, etc) or dumber than a sack of rocks. No middle ground exists. A friend/client told me about an experiment that struck me as telling. If you put a mouse in a cage where cheese appears 40% of the time on one side of the box and 60% of the time on the other, all mice eventually pick the side that "wins" 60% of the time. The mice stop guessing and go with what works more often than not.That's my theory for why the "intellectually challenged" crowd seems disproportionately likely to profit from trading. They see right through the noise to pick out a simple observation that wins more than it loses. Holy grail systems certainly do not come from this group. That's not honestly not the goal. It's about eating cheese more often than going hungry.
The brainy crowd benefits from a heavy dependence on analysis. Ideas usually stem from pet theories, many of which look like the crackpot variety on first glance. The theory shifts and twists as market tests reveal strengths and weaknesses. Logical conclusions instill a robustness and variety into the system. Interestingly, the approach to testing and verifying the systems follows the opposite path of most developers. The ideas tend to get simpler with time rather than more complex.
Emotion does not play a large role in the rationale for developing an expert advisor. Again, the reasons are usually logical. Examples like "I've been trading this system for 20 years and I need to automate it" or "I came up with a way to accurately predict market direction."
It may sound a bit zen, but the systems that make money are the ones that do not set their primary goals as making money. Making money is a totally open ended goal. The potential variables know no limit. The lack of constraint encourages would be EA traders to shoot off on tangents. Unless the wild ride accidentally leads to the pot of gold at the end of the rainbow, they will fail. The limitless bounds make it impossible to measure any progress.
In that same vein, the journey is as important as the destination. Many traders pay lip service to limiting drawdown. Few are able to effectively rein in drawdown, especially within the context of an expert advisor. To a certain extent, limiting drawdown is not possible. My experience with money management makes it clear how much wandering a return can make, even with a heavy advantage.
The easiest way to limit drawdowns is to fight against severe losses. The goal is to obsess over risk and reduce it to the lowest possible point. I want to emphasize this point carefully. Risk always exists. The market chaotically switches from deep slumber to extreme violence. No amount of system engineering eliminates or alters the structure of the market. The most effective way to handle risk that I see is not to prevent it from happening (not possible), but rather how to react when risk eventually flares up.
Approaching system design as a process rather than a destination also encourages global thinking. My old boss would describe it as the 40,000 foot perspective. When a forex trader, for example, emphasizes a system's percent accuracy, it typically comes at the expense of exiting at a better point in the market. A need to win slightly more often actually drags the system away from its optimal performance. A process oriented design watches how changes in the entry method affects the exit efficiency. Clever money management removes the emphasis from entry and exit methods.
Designing these systems takes hundreds of man hours or results from more than a decade of experience. Emotion will certainly enter the equation at some point. The real question is not how to remove it. It is how to appropriately channel it.
Designing an expert advisor quickly takes on the characteristic of an obsessive hobby. If the system's success is measured in quantities of dollars, the emotional roller coaster rises in tune with the account balance. A more appropriate use for the emotion is to take heart in the system working correctly, not profitably. Ideally, correctly also means profitably. They are not the same thing, however. Drawdown and unlucky losing streaks are an inherent part of trading. Gaining satisfaction from the trade behaving as designed rather than as desired makes your emotional well being far less dependent on market performance.
I have been running this company for nearly five years and literally spoken with thousands of traders over that time. In spite of that overwhelming number, I still have yet to speak with anyone that traded a commercial EA successfully for more than a few months.
The successful traders that I know personally all developed their systems and strategies on their own. Maybe that reflects on the abysmal quality of expert advisors for sale on the internet. Maybe it reflects on not-so-expert trading coaches, or perhaps genuine trading coaches and hapless traders unable to follow sound advice. I suspect it's a little of everything. Regardless of the problems, the take away point is that the person doing the succeeding is also the person doing the developing. They take control of the experience from the beginning and lead it into a successful outcome. Systems trading is not a process where you buy your way to success or follow like a sheep to green pasture. You must earn it.
Challenges of using a winning expert advisor
The path to achieving a profitable strategy on paper is a long, hard road. The switch from theoretical turns to live trading is a challenge in its own right. Backtests spit out instantaneous results. Traders see something like a 20% annual return, then mentally prepare themselves for the steady accumulation of funds.That kind of trajectory puts a number in the trader's mind that is terribly misleading in real life. Steady annual growth of 20% suggests a constant return of 1.67% (20/12). That number 1.67% is a hiccup in a trading account. Many forex traders risk more than that amount on a single transaction. Factoring in the inevitable drawdown or periods of loss, the market makes it impossible to distinguish whether or not the expert advisor is behaving correctly or if it is falling apart.
Uncertainty in the face of risk makes any normal person panic. At the very least, it instills a degree of anxiety over the future. The moment that the machine stops churning out profits is the moment where doubt enters the picture. Doubt feeds on itself, which leads to changing the trading plan in midstream.
I can tell you from experience that the transition from research to execution is huge. A learning curve exists, like with everything. I learn to cope by taking the confidence that I gain through the same debugging techniques used in testing. The same techniques work for comparing live results to backtested results. Does the backtest over the same time period as my real trading match the actual performance? If so, then all is well. If not, it at least gives me as the developer an opportunity to think about specific problems. Execution or forex broker manipulation can cause problems. More often that not, however, is some flaw in the strategy design or code. Developing a methodical, reason based process helps calm nerves and to stay focused. The alternative is a general, undefined worry.
Renko Backtests
Exotic bar types, as NinjaTrader likes to call them, create unique challenges when backtesting strategies. The primary problems is that the backtests are usually bogus. The trader often has no idea that the profitable backtest calculated from errant data.
Renko bars form based on the order of incoming ticks to create specific box sizes. Say, for example, that a trader creates a box size of 5 pips. If the price rises 5 pips from the close price of the last Renko bar, then the chart creates a new bar 5 pips tall. Every 5 pip increment, whether up or down, draws a new Renko bar.
Using increments that easily fall within normal market gaps creates the false impression of trade-able prices where none existed. Minor news events frequently result in 5-10 pip market gaps. In the case of the 10 pip gap, a box size of 5 pips creates 2 Renko bars. The two bars do nothing to communicate the fact that the prices never existed. Their presence merely indicates the direction of a move and eliminates the idea of time altogether. Time, or more specifically the absence of it, strikes me as rather important.
Small box sizes more commonly lead to questions about wildly inaccurate backtests. I received two questions last week inquiring why NinjaTrader showed $19,000 returns in a backtest, but the same forward test lost nearly an identical amount.
The backtests rely on a selected data set to generate the Renko bars used for testing. Users nearly always overlook the data source option in NinjaTrader. It defaults to one minute charts. One tick bid is the only type of data that will form perfectly accurate charts. Any other increment risks creating Renko bars that never existed.
Take
an extreme example of one minute chart data drawing Renko bars with a 3
pip box size. Say that the over-all height of the bar is 10 pips, the
low is 1 pip from the open and the M1 bar closes 8 pips higher. How many
Renko boxes does the chart need to draw? The correct answer is that
there is no way of knowing.
Examples:
It's done in good faith, but NinjaTrader is essentially making up Renko data to cover up gaps in the price data. When you're running a backtest, the whole point of the exercise is to eliminate guessing and deliver solid answers.
Most people make the hand waving assumption that it all averages out in the end. The two clients asking me this week about why their Renko backtests came out so screwy, and the reason that I'm writing this post, is that the hypothetical versus real performance was as different as night from day. It most certainly does not average out. Rather, it introduces so many errant points as to make the tests worthless.
Don't make assumptions in your backtest. Get tick data and, if you're using Renko bars, make sure to set the test up properly.
Renko bars form based on the order of incoming ticks to create specific box sizes. Say, for example, that a trader creates a box size of 5 pips. If the price rises 5 pips from the close price of the last Renko bar, then the chart creates a new bar 5 pips tall. Every 5 pip increment, whether up or down, draws a new Renko bar.
Using increments that easily fall within normal market gaps creates the false impression of trade-able prices where none existed. Minor news events frequently result in 5-10 pip market gaps. In the case of the 10 pip gap, a box size of 5 pips creates 2 Renko bars. The two bars do nothing to communicate the fact that the prices never existed. Their presence merely indicates the direction of a move and eliminates the idea of time altogether. Time, or more specifically the absence of it, strikes me as rather important.
Small box sizes more commonly lead to questions about wildly inaccurate backtests. I received two questions last week inquiring why NinjaTrader showed $19,000 returns in a backtest, but the same forward test lost nearly an identical amount.
The backtests rely on a selected data set to generate the Renko bars used for testing. Users nearly always overlook the data source option in NinjaTrader. It defaults to one minute charts. One tick bid is the only type of data that will form perfectly accurate charts. Any other increment risks creating Renko bars that never existed.
- Change your backtest settings to use not only Renko charts, but also Bid data.
Examples:
- The market goes down 1 pip, then up 10 pips and settles at the close price. This draws 3 total box with one box in progress.
- The market goes down 1 pip, then up 3 pips, then down 3 pips, then up 10 pips. This draws 5 boxes total with one box in progress.
- The market does down 1 pip, then up 3 pips, then down 3 pips, then up 3 pips, then down 3 pips, then up 10 pips. This draws 7 boxes total with one box in progress.
It's done in good faith, but NinjaTrader is essentially making up Renko data to cover up gaps in the price data. When you're running a backtest, the whole point of the exercise is to eliminate guessing and deliver solid answers.
Most people make the hand waving assumption that it all averages out in the end. The two clients asking me this week about why their Renko backtests came out so screwy, and the reason that I'm writing this post, is that the hypothetical versus real performance was as different as night from day. It most certainly does not average out. Rather, it introduces so many errant points as to make the tests worthless.
Don't make assumptions in your backtest. Get tick data and, if you're using Renko bars, make sure to set the test up properly.
Swiss banks give up names to end DOJ probe
Swiss banks are turning over thousands of employee names to U.S. authorities as they seek leniency for their alleged role in helping American clients evade taxes, according to lawyers representing banking staff.
At least five banks supplied e-mails and telephone records containing as many as 10,000 names to the U.S. Department of Justice, according to estimates by Douglas Hornung, a Geneva- based lawyer representing 40 current and former employees of HSBC Holdings Plc’s Swiss unit,Credit Suisse Group AG (CSGN) and Julius Baer Group Ltd. (BAER) The data handover is illegal, said Alec Reymond, a former president of the Geneva Bar Association, who is representing two Credit Suisse staff members.
“The banks are burning their own people to try and cut deals with the DOJ,” said Hornung. “This violation of personal privacy is unprecedented in the Swiss banking industry.”
Swiss banks want to settle a U.S. tax-evasion probe after the Justice Department indicted Wegelin & Co. on Feb. 2 for allegedly helping customers hide money from the Internal Revenue Service. Credit Suisse, HSBC and Julius Baer, which have said they expect to pay fines to resolve the tax matter, are handing over data to mollify the U.S., according to Hornung.
Credit Suisse said the Swiss government authorized the delivery of staff names and that the “large majority” of employees have nothing to fear. Julius Baer and Zuercher Kantonalbank also said they received authorization. HSBC said it has delivered documents and is cooperating with the U.S.
The Global (Not Euro-Zone) Crisis
Europe’s failure twice plunged the world into war. In today’s globalized economic world, Europe’s failure to resolve its financial crisis could plunge the world into economic chaos. This is a global crisis — not a euro-zone crisis — and we must take international action to deal with it.
http://www.nytimes.com/2012/08/16/opinion/the-global-not-euro-zone-crisis.html
http://www.nytimes.com/2012/08/16/opinion/the-global-not-euro-zone-crisis.html
Wednesday, August 15, 2012
Russ Wasendorf Sr. indicted
Peregrine Financial Group Inc. CEO Russ Wasendorf Sr. could face up to 155 years in prison if convicted on all counts, prosecutors said. His attorney didn’t immediately return a phone message Monday, and the date for an arraignment, where Wasendorf will enter a plea, has not been set. Peregrine operated as PFGBest.
Wasendorf, 64, a major player in Chicago’s futures industry, was arrested last month while hospitalized in Iowa City following a failed suicide attempt outside Peregrine’s office in Cedar Falls. Authorities said Wasendorf left a detailed suicide note in which he confessed to a 20-year scheme to commit fraud and embezzle customer funds.
For any PFG Best Customer, in case you have not seen this:
Important Message for Customers of Peregrine Financial Group and Peregrine Asset Management - Updated on August 3, 2012
As you aware, PFG filed for liquidation in a U.S. bankruptcy court in Chicago and the U.S. Trustee appointed Ira Bodenstein to act as trustee for PFG and its assets, including customer property. On July 13, the bankruptcy court authorized the trustee to continue to operate PFG's business for a limited time in order to (among other things) prepare and distribute final customer statements, and record transactions related to customer accounts. At this time, it is not clear how long it will take to complete these processes or when the trustee will be authorized to release any funds to customers.
The trustee has established a website, www.PFGChapter7.com, that contains information about the PFG case. The website was created to assist the trustee in providing information to customers and to receive comments or questions from customers. According to the website, the Trustee has not yet determined whether PFG customers will need to prepare a claim form. Customers are encouraged to visit the site regularly for updates from the Trustee regarding customer claims.
Tuesday, August 14, 2012
Knight Trading Loss Said To Be Linked To Dormant Software
Once triggered on Aug. 1, the dormant system started multiplying stock trades by one thousand, according to the people, who spoke anonymously because the firm hasn’t commented publicly on what caused the error. Knight’s staff looked through eight sets of software before determining what happened, the people said.
Knight, based in Jersey City, New Jersey, hasn’t explained in detail what caused the trading losses, which depleted its capital and led to a $400 million rescue that ceded most of the company to a group of investors led by Jefferies Group Inc. (JEF) The 45-minute delay in shutting down the malfunction has confused some securities professionals, who say that trading programs can typically be disabled instantly.
http://www.bloomberg.com/news/2012-08-14/knight-software.html
http://www.bloomberg.com/news/2012-08-14/knight-software.html
Monday, August 13, 2012
Capital flows signal new storm in Europe
Investors are losing confidence in the single currency and seeking havens for their cash outside the euro area asEurope’s debt crisis drags on in its third year. That has forced the Swiss National Bank to buy euros to prevent the franc from appreciating, and prompted the Danish central bank to charge for the use of its deposit facility while yields on U.K. two-year notes are less than 0.14 percent.
“Now there are growing signs that the crisis of confidence in the euro zone has assumed a new dimension,” Kressin wrote. “Whereas initially investors fled to the safety of the euro zone’s core, now they are taking their capital out of the euro zone altogether.”
The Swiss central bank’s sales of the euro to rebalance its reserves are “reinforcing” pressure on the single currency, according to Kressin. Its purchases of top-rated Europeangovernment bonds, particularly bunds, are also forcing down yields on those securities, he said.
Saturday, August 11, 2012
U.S. banks told to make plans for preventing collapse
(Reuters) - U.S. regulators directed five of the country's biggest banks, including Bank of America Corp and Goldman Sachs Group Inc, to develop plans for staving off collapse if they faced serious problems, emphasizing that the banks could not count on government help.
The two-year-old program, which has been largely secret until now, is in addition to the "living wills" the banks crafted to help regulators dismantle them if they actually do fail. It shows how hard regulators are working to ensure that banks have plans for worst-case scenarios and can act rationally in times of distress.
Officials like Lehman Brothers former Chief Executive Dick Fuld have been criticized for having been too hesitant to take bold steps to solve their banks' problems during the financial crisis.
Friday, August 10, 2012
Otmar Issing says Eurozone will break up
BRUSSELS - Former European Central Bank (ECB) chief economist and German central banker Otmar Issing has warned that the eurozone may split up - another voice in the chorus talking about a Greek exit from the common currency.
"Everything speaks in favour of saving the euro area. How many countries will be able to be part of it in the long term remains to be seen," Issing wrote in his latest book, entitled: "How we save the euro and strengthen Europe."
Thursday, August 9, 2012
Out-of-money Greece now prints its own euros
Alas, August 20 is the out-of-money date. September is irrelevant. Because someone else turned off the spigot. Um, the ECB. Two weeks ago, it stopped accepting Greek government bonds as collateral for its repurchase operations, thus cutting Greek banks off their lifeline. Greece asked for a bridge loan to get through the summer, which the ECB rejected. Greece asked for a delay in repaying the €3.2 billion bond maturing on August 20, which the ECB also rejected though the bond was decomposing on its balance sheet. It would kick Greece into default. And the ECB would be blamed.
But the ECB has a public face, President Mario Draghi. He didn’t want history books pointing at him. So the ECB switched gears. It allowed Greece to sell worthless treasury bills with maturities of three and six months to its own bankrupt and bailed out banks. Under the Emergency Liquidity Assistance (ELA), the banks would hand these T-bills to the Bank of Greece (central bank) as collateral in exchange for real euros, which the banks would then pass to the government. Thus, the Bank of Greece would fund the Greek government.
Precisely what is prohibited under the treaties that govern the ECB and the Eurosystem of central banks. But voila. Out-of-money Greece now prints its own euros! The ECB approved it. The ever so vigilant Bundesbank acquiesced. No one wanted to get blamed for Greece’s default.
Read more: http://www.testosteronepit.com/home/2012/8/8/greece-prints-euros-to-stay-afloat-the-ecb-approves-the-bund.html#ixzz235XoK0bz
Wednesday, August 8, 2012
Tuesday, August 7, 2012
Dark Pools
I picked up Dark Pools by Scott Paterson on Friday evening and finished Sunday afternoon. That ought to say something for the book's readability. I recommend it to anyone that trades, especially equities traders.
The structure of the stock market is far more complicated than I ever expected. Trading at Interactive Brokers, I always noticed that the execution venue would vary between different acronyms like ISLAND, ARCA and BATS. I knew that they were ECNs, but I never really understood what linked them together.
The stock market is not an exchange in the sense of a centralized location where all transactions occur. It is more like a listing entity where public companies go to list their shares. Actual trading occurs on any network plugged into the system.
The "exchange" is really a complex network of networks with varying degrees of favoritism shown to high volume clients.
Electronic Communication Networks ("ECN") originally started in the mid 1980s with the idealistic goal of eliminating the corrupt practices of the NASDAQ floor specialists and market makers. These guys were notorious (and later heavily fined) for colluding to artificially widen spreads on stocks for their own profits. ECNs would cut out the hated middle man while reducing errors, increasing transparency and dramatically decreasing execution time.
As one can imagine, the ECNs took off rather quickly. Not only did they offer much faster execution, but they were also about 60% cheaper to execute a trade.
They corruption that ECNs sought to eliminate inadvertently replaced one problem with another. Networks looking for liquidity offered trading rebates for limit orders that added orders into the system. The setup, which came to be known as maker-taker, created perverse trading incentives for participants. The more trades executed, the more the profits would add up.
Firms sought to become something like Walmart is to wide screen TVs. The more you sell, the more you make. The liquidity providers started fighting aggressively for inside placement of the spread to facilitate ever more trades.
The system spun out of control in two ways. It created a computing arms race where firms focused on purchasing cutting edge technology that shaves microseconds off of calculation time. Firms with the deepest pockets could literally buy an advantage through their computing hardware over the average Joe.
More importantly, the system itself bred its own corruption. The ECNs grew addicted to the liquidity fees. The more trades that fired off, the more money they made. They naturally started catering to their most important clients.
How they did it, though, is what sickens me as a trader. The ECNs started creating order types that were effectively secret. They allowed high speed firms to jump in line over retail chumps using vanilla limit orders. The ECNs offered colocation access at exorbitant fees to give the machines an edge. They allowed the creation of dark liquidity where some players could literally hide orders for execution while others displayed theirs 100% of the time. It makes a complete mockery of the idea of a level playing field.
Artificial intelligence played a big role in how the algorithms operate. What encouraged me, however, was how Patterson chose to wrap up the book. Many of the funds covered near the end start out as relatively small fish working with various types of AI to build predictive trading systems. Their initial results appear encouraging.
One of our biggest projects here is to use various models of fractal markets to build an automated trading system on behalf of the client that I go visit in Ireland so often. Andy and I meet on a near daily basis to discuss our genetic algorithm and how best to encourage the network to behave as we want it to. We are about a month from running our first predictive tests with our in house model. Reading this book encourages me that we are blazing down the right path.
The structure of the stock market is far more complicated than I ever expected. Trading at Interactive Brokers, I always noticed that the execution venue would vary between different acronyms like ISLAND, ARCA and BATS. I knew that they were ECNs, but I never really understood what linked them together.
The stock market is not an exchange in the sense of a centralized location where all transactions occur. It is more like a listing entity where public companies go to list their shares. Actual trading occurs on any network plugged into the system.
The "exchange" is really a complex network of networks with varying degrees of favoritism shown to high volume clients.
Electronic Communication Networks ("ECN") originally started in the mid 1980s with the idealistic goal of eliminating the corrupt practices of the NASDAQ floor specialists and market makers. These guys were notorious (and later heavily fined) for colluding to artificially widen spreads on stocks for their own profits. ECNs would cut out the hated middle man while reducing errors, increasing transparency and dramatically decreasing execution time.
As one can imagine, the ECNs took off rather quickly. Not only did they offer much faster execution, but they were also about 60% cheaper to execute a trade.
They corruption that ECNs sought to eliminate inadvertently replaced one problem with another. Networks looking for liquidity offered trading rebates for limit orders that added orders into the system. The setup, which came to be known as maker-taker, created perverse trading incentives for participants. The more trades executed, the more the profits would add up.
Firms sought to become something like Walmart is to wide screen TVs. The more you sell, the more you make. The liquidity providers started fighting aggressively for inside placement of the spread to facilitate ever more trades.
The system spun out of control in two ways. It created a computing arms race where firms focused on purchasing cutting edge technology that shaves microseconds off of calculation time. Firms with the deepest pockets could literally buy an advantage through their computing hardware over the average Joe.
More importantly, the system itself bred its own corruption. The ECNs grew addicted to the liquidity fees. The more trades that fired off, the more money they made. They naturally started catering to their most important clients.
How they did it, though, is what sickens me as a trader. The ECNs started creating order types that were effectively secret. They allowed high speed firms to jump in line over retail chumps using vanilla limit orders. The ECNs offered colocation access at exorbitant fees to give the machines an edge. They allowed the creation of dark liquidity where some players could literally hide orders for execution while others displayed theirs 100% of the time. It makes a complete mockery of the idea of a level playing field.
Artificial intelligence played a big role in how the algorithms operate. What encouraged me, however, was how Patterson chose to wrap up the book. Many of the funds covered near the end start out as relatively small fish working with various types of AI to build predictive trading systems. Their initial results appear encouraging.
One of our biggest projects here is to use various models of fractal markets to build an automated trading system on behalf of the client that I go visit in Ireland so often. Andy and I meet on a near daily basis to discuss our genetic algorithm and how best to encourage the network to behave as we want it to. We are about a month from running our first predictive tests with our in house model. Reading this book encourages me that we are blazing down the right path.
Subscribe to:
Posts (Atom)