... but our writer disagrees. Algos mean no harm

THE avarice and greed of traders leading themselves and others to ruin. The creation of powerful computer-driven algo systems that nobody understands. Another creation by grasping bankers trying to churn and burn viable publicly listed businesses as fast as they can. Whipping up uncontrollable market volatility. Exacerbating terrifying sounding “flash crashes.” All happening in the blink of an eye.

So far, all very H.G. Wells. And all great fodder for a blockbusting sci-fi novel by Robert Harris.

The only problem is that it’s pretty wide of the mark.

As horses speeding from the port to the market with news of a trading ship’s fortunes gave way to signal lanterns, which gave way to telegrams and telephones, which in turn gave way to fibre optic cables able to carry information around the globe in milliseconds, technology has come in for criticism.

When a system of lanterns was set up in the 1840s, allowing a message to be transmitted from New York to the Philadelphia stock exchange in less than 30 minutes, Abraham Lincoln warned that these dangerous advances would lead to increased market volatility.

And now that trades are measured in microseconds, rather than in minutes, it is high-frequency trading (HFT) that has drawn the ire of many.

FACT CHECKING
But does any of this criticism hold water? We decided to ask Fred Ponzo, managing partner of GreySpark Partners. Fred (right) works closely with banks, exchanges, clearing members and hedge funds to resolve issues they may have with their execution, risk management or trading functions. He therefore keeps close to all major regulatory and industry changes and developments, and an ear to the ground on what’s going on in the domestic and international financial markets.

“It is impossible to sustain a market making activity on a larger number of products and with tight spreads without HFT,” says Ponzo. “The simple fact is that if HFT wasn’t useful, then it would have disappeared years ago.”

The technological advances that we have seen in the trading sphere have of course been driven by the profit motive, but if it wasn’t for this one-upmanship, we’d still be living in caves, trying to kill each other with pointy sticks. Algorithmic trading – trying to make profits from discrepancies between two prices, or between a derivative and underlying asset, actually aids markets. And this effect is multiplied by electronic trading: “The key part of HFT is arbitrage,” says Ponzo. “Arbitrage removes discrepancy across asset prices and acts as a regulator.”

FLASH CRASH FEAR
But what about the issue of flash crashes? Huge amounts wiped off a share’s value, only to bounce back in the space of seconds. “We actually see fewer flash crashes than we did 10 years ago. In the past they were caused by human beings panicking – crashes were much bigger and took longer to recover.”

According to Ponzo, electronic trading, rather than acting as a detriment to market behaviour actually improves market conditions: “Because computers are making the decisions, it erodes a lot of the mania.”

Part of the reason why the new advances in technology provide such fuel for scare-mongering and for sci-fi novels is that they are such an unknown to the man in the street. Most people can understand that there are people who make a living because they can buy and sell shares more successfully than they can. They may not be completely enamoured with this, but as anybody can buy and sell shares through their friendly local stockbroker, it is something they can relate to.

Ultra low-latency high frequency trading of the same instruments is something different altogether.

But as Ponzo puts it: “People have a fear of high speed trading because it’s a bit like the leap from horse carriages to trains. Going from horses to trains was a leap in technology – but though people fell off horses all the time, when you have a train crash, though it happens less frequently it is more spectacular because of the speed.”

But that is no reason to ban trains – or HFT.

Craig Drake
craig.drake@cityam.com