Saturday, September 14, 2013

 

Can the human regulators defeat the robot traders?

Right now algorithmic traders can externalize the costs of their errors because the exchanges have agreed to a policy of canceling errant trades. This reduces the risk and the cost of trading electronically, which is one reason electronic trading has grown so large.  
A simple rule that required all executed trades to stand would create a huge incentive to improve systems or restore the role of human judgment in trading.
The bane of my existence as a trader was the exchange cancelling trades made in error by one of the big boys.  Back in the 90s errors were just mainly clerks for large banks/brokerages making fat finger mistakes, hitting the wrong button, and moving the market quickly in one direction or the other.  As small traders, we took the other side of these trades and the rule is to find another product and hedge immediately.  So if the trade was cancelled we were left with the naked hedge which usually meant a substantial loss.

Of course, the exchange never was as accommodating to us little guys.   I think high frequency trading (HFT) has destroyed liquidity so much that exchanges are starting to take notice.  I doubt they will be quick enough or go far enough to prevent the next HFT lead market meltdown.  


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