While the value of markets around the globe may ebb and flow, equity and derivatives exchanges have been firing on all cylinders of late with zooming volumes, spiralling market data and algorithmic trading seemingly in the ascendancy. But could traders be forgiven for thinking their future was in jeopardy?
Keeping up, interpreting and making faster and better trading decisions is unlikely to get any easier. IBM has even predicted that for every 40 traders active today for a given product, “only four will be left standing by 2015”.
Today around 40 per cent of trades on the London Stock Exchange are said to originate from algo trading systems, but Goldman Sachs has predicted that 60 per cent of the deals struck on the London market will be generated from black box systems inside 12 months.
That calls for a huge tooling up exercise to complete the end-to-end trading process. But incurring endless processing costs without profiting from trading is like using lots of bullets but missing the target.
People are now even talking about ‘latency’ arbitrage. Instinet Chi-X, a pan-European multilateral trading facility, which is expected to launch before year end to compete with exchanges and provide low-cost trading and “toxic” pricing, claims average round trip latency on a DMA (direct market access) trade is 10 milliseconds on its systems - 10 times faster than other European exchanges.
According to a report from IBM Global Business Services, Tackling Latency - the Algorithmic Arms Race, traders at firms on the world’s financial markets are “embarking” on a massive arms race akin to gunfighters in the Wild West.
This race “may mimic the military arms race…with the short-term focus on weaponry, being replaced by a longer-term focus on combat flexibility and war gaming strategy,” says co-author Keith Bear of IBM.
As in any gun fight where shooting fast and straight is a prerequisite, the difference to the markets is the target is moving and “the lone gun-slinger of the open outcry trading floors is rapidly being replaced by ultra-fast, computerised trading systems…more akin to robots with machine guns.”
Alasdair Haynes, chief executive officer of agency broker ITG (Europe), contends that: “The need for human judgement will always remain critical…now and in the future. Despite much deliberation on the fate of the trader there is no disputing that technology has dramatically transformed trading.”
Certainly, automation has overhauled the financial markets, in more ways than one, and helped in providing “unprecedented speed and flexibility” to traders. This has resulted in manifold increases in the volumes of stocks traded and gains for traders and their businesses alike.
But, given the complexity of the marketplace, regulatory pressures, proliferation of investment products and the pressure for operational efficiency and risk management, “entrusting trading to manufacturing style, conveyer-belt automation is a complete fallacy,” argues Mr Haynes. For him, the human element will “always remain” an essential prerequisite for trading, since the trader who is the one who “actually sets the criteria and parameters of trading.”
Bob Giffords, an independent IT and banking consultant, notes that the “trend” of prop traders having moved over recent years from the big dealers to the hedge funds will continue, although they will have to get smarter.
There will be changes in the role of the trader he contends, as the “low hanging fruit” is disappearing through the forces of supply and demand as well as shared models.
“Traders will focus more on complex transactions with commitments of capital. Supervising the automated trading processes, optimising and balancing the models and adjusting the settings or pulling quotes out
of the market from time to time,” says Mr Giffords.
Traders may also spend more time reading the ‘visible thinking’ of the electronic markets, reverse engineering strategies and taking positions on the herd instinct of the software writers. So perhaps more PhDs will be called for.
According to Mr Giffords the intellectual demands on traders on both buy and sell sides are hugely increasing.
“The prognosis, however, for traders is still very good,” contends Mr Giffords. “Demand for street-wise traders will always be with us… only now they will have to match their wits against software.” The human touch still has an important role in the complexity and fragmentation of the market, he asserts.
The growth of DMA on the buy-side, and globalisation with its demands for specialist knowledge of different regions and sectors and instruments, means that a “safe pair of hands on the tiller” will be in strong demand for the foreseeable future.
“It’s true that algorithms in their very basic form, are designed to automate trade executions. However, algorithms are only one of the trading tools available to traders,” says Mr Haynes.
To maximise investment returns traders need to use a “combination”, and according to Mr Haynes “deciding which of these tools and venues to use at different stages of the trading process requires human involvement.”
Second generation algorithmic products to allow traders to interact with the execution process.
“Such interactive algorithms can help traders capture alpha and boost portfolio performance. In fact, the growing sophistication of algorithms is resulting in their increased use for more difficult trade orders such as large blocks or illiquid securities,” Mr Haynes adds.
In short, according to Mr Giffords “the imminent demise of the trader is highly overrated and I wouldn’t hold my breath.”
