How to Make Money in Microseconds | Donald MacKenzie in the London Review of Books
How to Make Money in Microseconds | Donald MacKenzie in London Review of Books
Fascinating account of how trades on stock exchanges, and across different exchanges are conducted in microseconds using automated algorithms. It introduces you to the “most common execution algorithm, known as a volume-weighted average price or VWAP algorithm (it’s pronounced ‘veewap’)”, used to sell and buy large blocks of shares by breaking them up and avoiding ‘slippage’ (because selling - or buying - a large block of shares takes ‘a while’ to process those monitoring the exchange notice and start to use the information to buy and sell the shares, which results in a ‘slippage’ of the price). A big VWAP however, is still prey to a process called ‘algo-sniffing: “if the VWAP is programmed to buy a particular corporation’s shares, the algo-sniffing program will buy those shares faster than the VWAP, then sell them to it at a profit.” While Algo-sniffing is indisputably legal, however, ‘layering’ or ‘spoofing’ algorithms do seek deliberately to fool other algorithms. “A spoofer might, for instance, buy a block of shares and then issue a large number of buy orders for the same shares at prices just fractions below the current market price. Other algorithms and human traders would then see far more orders to buy the shares in question than orders to sell them, and be likely to conclude that their price was going to rise. They might then buy the shares themselves, causing the price to rise. When it did so, the spoofer would cancel its buy orders and sell the shares it held at a profit.” These trades occur not in the stock exchanges of old, but in huge data centres with banks of connected computers which are supervised by a handful of maintenance staff. The further away the trading is, no matter how good its fiber optic connection is means that trading can only occur so quickly, however, - the limitations of space and the speed of light still apply.
And of course, there are significant dangers…
“The credit system that failed so spectacularly in 2007-8 is slowly recovering, but governments have not dealt with the systemic flaws that led to the crisis, such as the combination of banks that are too big to be allowed to fail and ‘shadow banks’ (institutions that perform bank-like functions but aren’t banks) that are regulated too weakly. Share trading is another such system: it is less tightly interconnected in Europe than in the United States, but it is drifting in that direction here as well. There has been no full-blown stock-market crisis since October 1987: last May’s events were not on that scale. But as yet we have done little to ensure that there won’t be another.”
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