The electronic herd

A concerning but far from an unexpected headline from @zacharykarabell on @WIRED

How Technology Unsettled The Stock Market.

A takeaway...

"JP Morgan recently estimated that only 10 percent of trading now consists of people trading with people based on fundamental decisions about company A or company B."

If you know anything about finance, you'll have seen this moment coming. Like peak oil, polar bears or our obsession with plastic, it seems that we're only going to try to figure out what to do about this enormous imbalance and the subsequent risk of world-encompassing catastrophe now that we're dangerously close to being beyond the point of turning back. 

Electronic trading has brought billions of dollars of profit to the world's biggest money managers and banks. Those who wrote the algorithms and harvested the electronically-gotten gains over the last 30 years have been ludicrously rewarded. But, potentially, they've also built an Armageddon machine, one that could be more toxic than any other bubble. 

The problem this time around is that it isn't a sub-section of the market that is facing the implications of electronic trading. It is the entire market, all $30 trillion of it. 

And the regulations and systems have no idea what happens when this infinitely-tuned system breaks down. We've seen moments of madness - flash crashes, as they're generously called - but we've yet to see a major correction. 

The way these algorithms work relies heavily on momentum. But the momentum that could be generated in a market when these programs begin to get out of sync could be catastrophic. Like a runaway herd of a thousand buffalo, turning them back when they get running downhill will be all-but-impossible for human cowboys. 

Most frighteningly, whilst machines now do the trading, it is not their money to trade. It is our money. It is our pensions, savings, mortgages, our futures that are relying on their careful, disciplined management. They have our future in their hands. 

As Kabell concludes, "the rise of the machines need not be a threat, but unless we plan for it, the entire financial system is at risk." 

The time for planning may well have passed.  

Edward Playfair