Black Box Trading Vs People = Volatility

In electronic financial markets, algorithmic trading or automated trading, also known as algo trading, black-box trading or robo trading, is the use of computer programs for entering trading orders with the computer algorithm deciding on aspects of the order such as the timing, price, or quantity of the order, or in many cases initiating the order without human intervention. Algorithmic Trading is widely used by pension funds, mutual funds, and other buy side (investor driven) institutional traders, to divide large trades into several smaller trades in order to manage market impact, and risk.^[1][2] Sell side traders, such as market makers and some hedge funds, provide liquidity to the market, generating and executing orders automatically. 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.

Algorithmic trading may be used in any investment strategy, including market making, inter-market spreading, arbitrage, or pure speculation (including trend following). The investment decision and implementation may be augmented at any stage with algorithmic support or may operate completely automatically ("on auto-pilot").

A third of all EU and US stock trades in 2006 were driven by automatic programs, or algorithms, according to Boston-based financial services industry research and consulting firm Aite Group.^[3] As of 2009, high frequency trading firms account for 73% of all US equity trading volume.^[4]

In 2006 at the London Stock Exchange, over 40% of all orders were entered by algo traders, with 60% predicted for 2007. American markets and equity markets generally have a higher proportion of algo trades than other markets, and estimates for 2008 range as high as an 80% proportion in some markets. Foreign exchange markets also have active algo trading (about 25% of orders in 2006).^[5] Futures and options markets are considered to be fairly easily integrated into algorithmic trading,^[6] with about 20% of options volume expected to be computer generated by 2010.^[7] Bond markets are moving toward more access to algorithmic traders.^[8]

One of the main issues regarding high frequency trading is the difficulty in determining just how profitable it is. A report released in August 2009 by the TABB Group, a financial services industry research firm, estimated that the 300 securities firms and hedge funds that specialize in this type of trading took in roughly $21 billion in profits in 2008^[9].

...High-frequency trading In the U.S., high-frequency trading firms represent 2% of the approximately 20,000 firms operating today, but account for 73% of all equity trading volume.^[19] As of the first quarter in 2009, total assets under management for hedge funds with high frequency trading strategies were $141 billion, down about 21% from their high.^[20] The high frequency strategy was first made successful by Renaissance Technologies.^[21] High frequency funds started to become especially popular in 2007 and 2008.^[20] Many high frequency firms say they are market makers and that the liquidity they add to the market has lowered volatility and helped narrow spreads, but unlike traditional market makers, such as specialists on the New York Stock Exchange, they have few or no regulatory requirements.

High-frequency trading is quantitative trading that is characterized by short portfolio holding periods (see Wilmott (2008), Aldridge (2009)). There are four key categories of high-frequency trading strategies: market-making based on order flow, market-making based on tick data information, event arbitrage and statistical arbitrage. All portfolio-allocation decisions are made by computerized quantitative models. The success of high-frequency trading strategies is largely driven by their ability to simultaneously process volumes of information, something ordinary human traders cannot do. Various types of high-frequency strategies are covered in Aldridge, I., "High-Frequency Trading: A Practical Guide to Algorithmic Strategies and Trading Systems" (Wiley, 2009).

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Double Dip Recession or Not? Maybe the Bond Market Knows

Looking back at the start of this year, the markets began the year with good cheer and likely a fair dollop of complacency. Fast forward to the second quarter, and all of a sudden the PIIGS group of countries, double dip recession, and stubbornly high unemployment began to gain investor attention.

As has been commented upon in this space before, the bond market tends to be a better prognosticator of the economy’s direction than the equity markets - most of the time. In general, rising bond yields have correlated with rising equity markets and falling bond yields (i.e. falling interest rates) come about as economic uncertainty gives rise to fear and panic.

So much effort is often expended on trying to predict market direction or how much the economy will grow (often turning out to be a fruitless endeavor) that all too often the obvious is missed. From our perspective, we have been keeping a keen eye on the 10 year Treasury yield (i.e. the level of interest investors are “charging” to be lenders to the US Treasury).

Even the 2 Year Treasury yield has come down to record lows as the bond market begins to price in an economic slowdown and the potential for deflation to set it in. At this point, perhaps it is too much too soon. Markets (including bond yields) never go up or down in a straight line. But since April, our line in the sand was drawn as we watched investors run for the safety of the bond market. This line in the sand was drawn at the 3.10% level. As we can see from the chart below, the line in the sand has been breached.

Read more: http://business.financialpost.com/2010/06/30/double-dip-recession-or-not-maybe-the-bond-market-knows/#ixzz0sQnDZ7mY

At these levels, the bond market has discounted little fear of inflation. The gold bugs have been pounding the table for years about the coming inflationary crisis that will be fueled by the printing of money by the world’s central banks.

From the most recent data from the US Federal Reserve and the European Central Bank (ECB) it would seem that all of the monetary grease that they have put into the economy is not making its way into the economy – and this will be the case so long as the banking system globally is not running at optimal efficiency.

It is hard to argue inflation when US GDP numbers are being revised lower (not higher) for the last two quarters, Europe is undergoing spending cuts and tax increases, and even the Canadian economy has seemingly hit a rough patch for the month of April – surprising many an economist. Yet if they would bother to pay attention to the bond market (above chart), an economic deceleration has been slowly getting priced in.

However, that slowdown scenario does not presage yet another recession or double dip. A double dip recession is an infrequent occurrence – happening only once since the Great Depression. However, for many individuals looking to recover from the last recession or to get back into the labor force, the words “double dip” or “economic slowdown” are just semantics – the impact is real.

AJ Sull, CFA, MBA, CMT