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Gambling Millions in Milliseconds: The Global Economic Risk of Automated Trading

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Have you seen Kevin Slavin's excellent TED Talk about how algorithms shape our world? He delves into some pretty scary facts about the world's financial markets, including the stunning fact that the majority of the trading going on in the world is being done by automated computers at speeds beyond which humans operate. A little information about automatic trading from Wikipedia:

A special class of algorithmic trading is "high-frequency trading" (HFT), in which computers make elaborate decisions to initiate orders based on information that is received electronically, before human traders are capable of processing the information they observe. This has resulted in a dramatic change of the market microstructure, particularly in the way liquidity is provided.

So computers are auto-generating news that other computers are auto-parsing in order to make lightspeed auto-trades that are actually changing the structure and liquidity of the markets? Keep this in mind: today, over one-third of United Kingdom equity trading volume is generated through high frequency automated computer trading while in the U.S. this figure is closer to three-quarters. As of 2009, high-frequency trading firms, which represent approximately 2% of the 20,000 or so trading firms operating in the U.S. markets today, accounted for 73% of all U.S. equity trading volume. With billions and even trillions of dollars moving through the markets daily, one bad mistake in a computer program and everyone's 401K is history.

This is high tech automated gambling via computers spinning algorithms that count in milliseconds, soon to be nano-trading of atomic money particles via quantum physics, no doubt. It is gambling, it is automated and it is not perfect, which means sometimes it fails. Remember the May 6, 2010 flash crash? The Dow Jones dropped over 600 points in five minutes when blazing fast automated trades triggered a crash. Twenty minutes later, most of that drop was magically erased. According to Wikipedia, it was the second largest point swing, 1,010.14 points, and the biggest one-day point decline, 998.5 points, on an intraday basis in Dow Jones Industrial Average history.

That was computer algorithms miscalculating. Nine percent of the market vaporized and then suddenly, almost all of it returned. And if it hadn't? Oh well. Think of these algorithms next time any politician wants to "privatize" your Social Security. Pensions, retirement funds, college funds; all are susceptible to this machine error. And there is no undo function for a market crash of that character. Its money evaporated. Considering the way the Fed prints money, one could wonder if it ever truly existed in the first place. The politicians who would seek to privatize your Social Security have no problem putting your hard earned savings into the money grinder, like Indiana Jones into the pit of snakes; but instead of snakes, they're algorithms. And they don't care or feel, they have no emotions. They crunch numbers, not think about whether your grandmother is losing her house or whether your retirement fund is secure. It is up to the people who program and run these algorithms to care, if at all. But while luck is in their favor, gamblers tend to lose sight of anything but more, more, more. 'There must be more money!' shouts the boy in D.H. Lawrence's The Rocking Horse Winner but alas, there is never enough. And the algorithms keep moving, learning and evolving to react to every molecular movement with sub-molecular speed. And all to make money.

Besides the obscene amounts of money at stake, look at what the money motivates. Companies are actually installing hundreds of millions of dollars worth of equipment across earth and ocean to achieve this algorithmic efficiency. Two examples of the infrastructure being put in place for the purpose of increasing algorithmically-based automated trading speed are the Trans-Atlantic fiber-optic cable being laid down between New York and London and the new quicker route between Chicago and New York. U.S.-company Spread Networks opened the new connection between Chicago and New York at a cost of around $300 million just to save about three milliseconds on an automated trade. For overseas trades, check out the 3,000-mile Hibernian Express, the first transatlantic cable in a decade being installed between New York and London. This one is being used to save a whopping six milliseconds in data transfer speed for stock trades and the hedge fund managers and currency dealers are already lining up for the 2013 grand opening. With costs of over $400 million dollars just to install this speed-saving device, can you imagine how much money they are going to make just by saving those six milliseconds? The algorithms can, and the algorithms have told them 'There must be more speed!' Unless you want your microtrades happening milliseconds too late to take full advantage of this insane automated computer gambling.

Do not insult the term "investing" by calling this whole thing exactly what it is: computers auto-gambling, mostly with made-up money. Leverage or lack thereof is a huge part of this. Even though these bets are being made with leveraged debt, a lot of people are going home with real profits, living 1% of the Top 1% lifestyles while letting the computers rake in the dough, microbit by microbit. "A couple of milliseconds can roll out to a $20-million difference in [a trader's] account at the end of the month," says Nigel Bayliff, the CEO of Huawei Marine Networks, one of the companies laying down superfast fiber-optic lines. That's not $20 million total a month, just $20 million more each month. And all from a couple of milliseconds in speed of trade. And when it comes time to pay taxes, you pay a capital gains tax of 15% on your billions in profits instead of normal income tax. And you wonder why the Occupy movement is pissed? You're gambling with fake money and extracting real wealth from the country. And no one knows if you are bending the rules or not because nobody really understands what you're doing. Here's a telling quote from capital market guru Larry Tabb, CEO and founder of TABB Group:

"Increasingly, as more and more [financial trading] is being done electronically, there's no market center," Tabb says. "There's no guy you can talk to and ask, what's going on? Because it's all being done by robots, outside of anybody's eye."

Robots gambling with the world's money so fast that they'll stretch cables across oceans just to gain a few milliseconds of speed. (For reference, five milliseconds is about the amount of time it takes a bee to flap its wings.) And all for the sake of gambling. But this kind of gambling is nothing like an individual sitting at a slot machine in a casino. There are shared characteristics -- compulsion, addictiveness and unleveraged risk. Add ego or alcohol, they can be quite deadly. But what they don't share is scope. The speed, the micromaneuvering, the level of risk and the susceptibility to fraud, all of it is on a hyper level where bad decisions or malfunctioning software can bring more immediate and global results. And here is where the risk of gambling is at its greatest. The lone gambler might go into debt and lose one family's savings. But the robots will tank millions of people's life savings without batting a microchip.

Follow up on the Flash Crash

After almost five months of investigations led by Gregg E. Berman, the U.S. Securities and Exchange Commission (SEC) and the Commodity Futures Trading Commission (CFTC) issued a joint report dated September 30, 2010 and titled "Findings Regarding the Market Events of May 6, 2010" identifying the sequence of events leading to the Flash Crash. The joint report "portrayed a market so fragmented and fragile that a single large trade could send stocks into a sudden spiral."

Now that we've assessed how risky our global economy still is, let's finish up by estimating just how much money is being traded in our markets:

The European Commission recommended in September that the 27 European Union member countries adopt a 0.1 percent tax on financial transactions beginning in 2014. It estimated that the tax would raise $78 billion a year. That would make the total estimated transactions in the EU about $78 trillion.

That's $78,000,000,000,000.00

But Europe hesitates to institute the tax without a similar levy in the United States. So in November, two U.S. lawmakers who have long supported the levy introduced legislation to impose a smaller tax -- .03 percent (3 cents on $100) in transactions. The tax proposed by U.S. Rep. Peter DeFazio, D-Ore, and Sen. Tom Harkin, D-Iowa, would raise about $350 billion over a decade.

$35 billion a year x 10 = $350 billion a decade

$35 billion is .03 percent of $116.6 trillion

That's $116,666,666,666,666.67 trading annually in the U.S. financial markets, mostly by automated computers.

Anybody feeling any safer?