Hack the market

I’ve been saving the above image in a stubbed-out blog post I’ve wanted to write since a conversation I’d had in Jerusalem last fall.  The recent attention to high frequency trading and all of its attendant evils has reminded me that the topic is relevant and so I relate various thoughts at the risk of jumping on a cacophonous bandwagon of rumbling misinformation.

First of all, the conversation.  It was with a talented guy who acted as the CFO for a variety of companies including a small startup hedge fund which traded US equities at a high frequency.   Although he was a part-time cfo, he seemed pretty plugged-into their trading operations and noted that they use an agency-only brokerage service for automated traders I’m familiar with and that they were “looking at full data for many” hundred stocks concurrently. He remarked that their trading was going well but that their hit rate was something like 4% and dropping.  By hit rate, he meant that they were placing limits frequently and generally pulling the orders if they didn’t get hit immediately.  He didn’t specify, but I imagine that “immediately” might range from milliseconds out to a second or twenty.  If the market is composed of makers and takers, then these guys were definitely makers of liquidity in the strict sense that they were placing limits and making markets.

At the time I thought it was interesting because it seemed that so many people were focused on the very, very short term trade that the frequency was becoming saturated.  It looked like a reminder that trading frequencies populate a spectrum; in this case, this part of the spectrum was becoming so saturated that returns were becoming increasingly difficult to obtain as more players crowded into it.  I’m not sure how this hedge fund has fared, but at the time I remember thinking that they were going to have a tough time competing if they were only geared for high-frequency trading as the space becomes increasingly expensive to play in as the inevitable talent and technology arms race marches on.

Lo and Khandani provide the below image illustrating this phenomenon happening to a class of contrarian strategies Lo & MacKinlay had described in 1990.  The strategies stop working as people squeeze out the alpha.

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hedge funds, our managed markets, startup, strategy development, technology

as suspected, the seat of evil can be found in NJ

There’s a whole bunch of interesting things about this story of how a programmer has allegedly stolen some of the code at the place he’d worked.  One is the remarkable reverb it’s created amongst bloggers.  The house pictured left is evidently the diabolical mastermind’s home according to the NJ Real Estate Report.  Another is the fact that a programmer stealing some code is news. Funny what becomes news (apparently a fêted pedophile died) and what doesn’t (we are creating millions of refugees in Pakistan).

One angle that I haven’t seen highlighted in all of the commentary is Mr Aleynikov’s choice of weapon.  Seems that he was an erlang guy with an interest in ocaml.  Choosing functional programming for algo trading systems is an interesting but not unique choice.

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our managed markets, strategy development, technology