Mankind’s most enduring quests have been for perpetual motion and the philosopher’s stone. Physicists have stopped seeking the first, bowing to a law that energy can neither be created nor destroyed. Dismal scientists are a hardier lot, they persevered in their search for something — anything — that has King Midas’ touch, be it stone, acid or algorithm. In flash trading, investment bankers have come up with something pretty close. Here’s how it works. Supercomputers execute thousands of orders every second on the world’s biggest exchanges and harvest micro-profits much before the information they worked upon can be processed by a human brain. How many chess players stand a chance against Deep Blue?
Just to be safe, these number-crunching beasts are housed among the stock exchanges’ server banks so that market data reaches them a fraction of a second before it pops up on Joe Trader’s terminal. For most part man is not in the picture at all, investment banks play the high-velocity game with each other on computers hosted by the brokerages themselves. Half of the trading in the US is conducted as a millisecond’s digital dance, with exchanges and investors looking on. The big bulls are the blokes with astounding computing power and incredibly advanced trading programmes. Goldman Sachs, the high priest of blitz trading, made $100 million from its propriety algorithms in 46 trading sessions, reckons Bloomberg.
Regulation, as is its wont, is playing catch-up with human ingenuity. Stock market watchdogs on both sides of the Atlantic are muttering darkly about “direct edge” and “dark pools”. Both phenomena have existed since stock trading went paperless, it’s just that their current degree is fearsome. Select traders on exchanges have access to more information than the average investor, but most bourses put out a list of their elite membership. Exchanges will be under pressure to disclose whose supercomputers they are hosting if they do not want discriminatory access banned. Brokerages will also face more forceful calls to tell about off-market trades with their clients’ and their own money. After the latest episodic lapse, the world is yet to recover from regulatory failure in the more esoteric branches of finance. These new money-making monster must be tamed. The last man with a golden touch had a sorry tale to tell.