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

Ellen Roseman's Canada

I like scenery as much as anyone. But I don’t think about the landscape when I think about being Canadian on Canada Day.

I think about the people and their attitudes, often called the collective soul of Canadians — polite, courteous, civil and restrained. It’s what makes Canada the peaceful country it is and a beacon of hope for emigrants around the world.

But often, I find my fellow citizens too complacent, too trusting of authority, too willing to believe that every problem has a legislated solution.

Why do so many people sign long-term contracts for car leases or phone plans without reading the fine print or asking about the consequences if they have to cancel early?

Why do they trust the promises of door-to-door sellers pushing fixed-price energy deals or telemarketers offering lower credit card interest rates?

Why don’t they shop for financial advisers as carefully as they shop for plumbers, gardeners and roofers?

Why do they start and end their quest for financial products at their bank branch?

I’m exasperated to see people let go of their common sense when confronted by persuasive sales pitches or seductive marketing campaigns. And I’m trying to figure out why it happens.

Perhaps it’s the sense of entitlement you get in a country with strong social supports, leading you to assume there are strong laws to enshrine consumer and investor rights.

If only it were so.

Canada’s division of power between provincial and federal governments has resulted in fragmented legislation and enforcement.

Too often, government regulators hand over power to self-regulatory bodies funded by the industries they’re supposed to police.

Canada’s politicians pay little attention to consumer and investor issues until they erupt into protest marches, front-page news stories and questions they can’t duck in Parliament or provincial legislatures.

Years can go by without a controversy that forces legislators to act.

Remember the furor about Rogers making customers pay for bundled cable TV channels unless they said they didn’t want them? The story comes up a lot when you talk about consumer activism.

But it happened 15 years ago. And there’s still no law against negative-option billing by federally-regulated telcos and banks.

I want Canadians to stop assuming that large corporations and salespeople have their best interests at heart. I want them to put more emphasis on self-protection and less reliance on government to come to their aid.

That’s my Canada Day wish.

Robot stock selector finds its way in a tough market

As bad as the year has been for investors tagging along with the stock markets, it was still possible to make money.

You just had to be selective, and buy stocks that paid dividends.

Ten Canadian stocks we selected using a robotic or automated filtering technique would have earned us about $92,000 in six months, if we had only had a million dollars and the courage to invest it on the eve of 2010.

Holding all of the stocks tracked by the Standard & Poor’s/TSX composite index would have cost us about $25,400, plus brokerage fees.

Toronto’s index fell by 3.85 per cent in six months, although dividends limited losses to 2.54 per cent.

Meanwhile, seven of our 10 stocks rose in value, including drug maker Biovail Corp. by 39.7 per cent.

This has been a period of uncertainty regarding growth in the global economy, anxiety about mounting government debt and a flight to the perceived safety of gold and U.S. government bonds.

Most other major stock markets have fallen more than Canada’s after the exceptionally strong gains last year.

Yet many stocks did continue to rise in value. Our Robot Portfolio selection technique, popularized in earlier news columns by Boston money manager John Dorfman, seems to have drilled through to find some hidden value.

We cannot say this always works, however. Earlier portfolios gained 30 per cent gain in 2006, and 68.5 per cent in 2009. But we lost 5 per cent in 2007 and 40 per cent in 2008, a worse performance than the markets as a whole. Our average gain over four years was only 5.7 per cent a year, ignoring trading fees and taxes.

Each time we chose 10 companies with 10 different specialties. All had a market value of at least $500 million, more shareholder equity than debt, at least a penny of profit per share in the latest four quarters reported and a low share price relative to earnings.

Our biggest winner this year, Biovail, shot up in price on news it had agreed to merge with Valeant Pharmaceuticals International Inc., a California maker of generic drugs and treatments for chronic illnesses. The combined companies will have operations in several countries, but with a workforce nearly 20 per cent smaller.

A big gain of 27.6 per cent was posted by Western Coal Corp., which mines coal in British Columbia and West Virginia for makers of metal and generators of electricity. It has seen a decline in revenues, but every analyst tracked by Bloomberg rates the stock a buy.

Shares of Telus Corp., the telephone company, produced a 20.9 per cent gain. It turned in a slightly higher profit in its latest quarter, even though revenues were flat, new competitors are challenging its share of the cellular telephone market and analysts differ on whether to buy the stock.

Yellow Pages Income Fund, another company facing challenges and a lack of enthusiasm from analysts, defied the odds and turned in an 18.3 per cent investment return. It recently expanded by acquiring Canadian Phone Directories Holdings Inc.

Natural gas extractor Peyto Energy Trust provided a 9.1 per cent gain, while cheque printer Davis + Henderson Income Trust added 3.4 per cent and power generator and natural gas distributor ATCO Ltd. added 4.3 per cent.

Capstone Mining Corp., which mines copper, silver and zinc, and operates in Canada and Mexico, was the biggest disappointment, posting a 23.1 per cent investment loss. Fairfax Financial Holdings Ltd. provided a 2.4 per cent investment loss, while Precision Drilling lost us 7.7 per cent.

We will see at the end of the year whether our overall gain holds up. In the meantime, you should know we are providing the information as a matter of interest only. We are not offering investment advice.