Hack the market

photo credit: Jochen Abitz @flickr

This past spring I was compelled to rejoin what one of my former partners had longingly referred to as “civilization.” The process of rejoining the civilized was itself of note in an environment so changed as to be unrecognizable, but I’ll skip that for now.  Instead I have some observations on the interesting spot in which I’ve found myself: writing dark pool aware algos from the inside.  That is, I’m working for a block trading ‘dark pool’ working on the team that develops their quantitative strategies.

While still within the world of algorithmic trading, this is a substantial change from what I’d been doing before and has proven a rich ground for learning, in particular about market structure.  The biggest aspect of the change – besides being civilized – is the change of perspective from the prop trader to, effectively, an execution trader.  As a prop trader you are looking to identify and execute trading opportunities.  Seeking alpha.  Instead, as an execution trader you receive orders and need to execute them with some highly customized sets of constraints.  You want to get things done over some time frame with some appropriate balance of aggressiveness and stealth.  Liquidity seeking.  The ‘what’ has already been decided for you; it’s the ‘how’ you need to worry about.  Thus, there’s some loss of ‘agency’ in going from the former role to the latter and this corresponds precisely and inversely with the notion of agency trading.

Going from alpha-seeking to seeking-liquidity is a change of perspective, but the blocking and tackling are constant.  In the end, you’re trading – managing orders and positions and deluges of market data and analytics; familiar, fun stuff.

What I’ve found most interesting is the new perspective I’m afforded on market structures.

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Like many Americans, last night I dutifully switched on my TV at 9pm to see the State of our Union.  Always a spectacle, America’s leadership have upped the surreality ante with the bizarre backdrop of Biden lip-synching amiably in the background whilst Madame Speaker sat with all the calm collection of a fish on a hook and never seemed fully in control of herself or her eyebrows.  The spectacle of would’ve-been king McCain sitting there and glowering openly at the lecturn as his confederates sat in stony silence while their ‘opposition’ applauded like drunken high schoolers at a home coming at every mundane utterance proved a bit much and I had turned off the glowing beacon of groupthink by 9:25 and gone to investigate something on my computer.  I was surprised and delighted to see that it was still available: dingbatkabuki.com

Dingbat Kabuki and other structural market hacks

When I first started puppetmaster trading, one of my dearest friends, a Yale-educated economist and professor of same, asked me an important question.  He asked:

In the markets, there are always ‘insiders’ who have the ability to trade on knowledge that you can’t know or with an advantage that you can’t have.  How are you going to compete with these players?

I provided a variety of answers, but at the time my conception of the universe of people with both inside knowledge and the ability to trade on it was limited to cases like that of Mr Rajaratnam.  I believed that cases like these were constrained by clear laws that were duly surveilled and prosecuted by the appropriate authorities.  The problem seemed like a very real one, but constrained in size and not essential to my enterprise.  I still hope that my belief of the time was true, but since then I’ve certainly understood that there’s more than one way to hack the market.

For some, a market hack might consist of some kind of simple (or complex) algorithm(s) applied to some set of markets.  But this really isn’t a hack so much as it’s a trading strategy – like many that have long existed – only that it’s now implemented in software where originally it would have been implemented in wetware.  While implementing trading strategies in software does open up new vistas in terms of the kinds of strategies that you can look to implement – computers are faster than people by a noteworthy amount in many tasks – but, for the most part, you’re really still just trading and when you take on positions, you are still bearing risk.  You might be ‘hacking’ but it’s really not a market hack as I’ve come to appreciate.

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