subject: Geeks trump alpha males as 'algos' dominate Wall St posted: Thu, 03 Dec 2009 15:25:11 -0000
[The quants are baaaack..... quantitative trading got a bit of flack
during credit crunch, no lasting damage, apparently - possibly the
opposite. - Stu]
Wall Street traders aren't what they used to be - they're not even on
Wall Street anymore.
The days of swashbuckling backslappers on the floor of the New York
Stock Exchange have given way to an era of trading dominated by
analytical technical whizzes whose computers may be running from a
town in deepest New Jersey or Texas.
While street smarts and an ability to socialize were crucial to
successful floor traders, today's trader needs math and computer
science, and quite possibly a PhD.
And that has to be coupled with coolness, organization and logic to
sift through masses of trading data each day and think about how to
shave microseconds off trades.
"The old markets were based on retribution - I knew who you were and
you would trade with me again and again, and if you didn't treat me
right I wouldn't trade with you," said Al Berkeley, chairman of
electronic brokerage company Pipeline Trading Systems and former vice
chairman and president of the Nasdaq Stock Market.
"The difference is anonymity. If you play a game with the same people
over and over again, you reach an understanding about what's
acceptable. If the game is completely anonymous, there are no rules
between people, there are only rules imposed by the marketplace."
The outsized growth of high-frequency trading, dark pools of
liquidity and high-tech computer algorithms has fundamentally changed
the game on Wall Street - and the psychology of those who work there.
Traditional floor trading "really is an alpha-male activity," said
Brett Steenbarger, and an associate professor of psychiatry at State
University of New York at Syracuse and an expert in the psychology of
trading. "You get these highly competitive people taking a good
amount of risk... It's like being in a locker room. In contrast,
computer programmers are almost like a think tank."
Now, with high-frequency trading representing some 60 percent of U.S.
stock trades, the atmosphere appears to owe as much to Arthur C.
Clarke and artificial intelligence as to Gordon Gekko and the 1987
movie "Wall Street."
"They are introverts, some are socially awkward, and they don't seek
publicity. They are the type of guys you would see at a Star Wars
convention," said Sang Lee of Aite Group.
High-frequency traders are practical, problem-solving people with an
engineering background. "It's a very intellectually challenging field
-- it's extremely exciting to develop a strategy, implement it and
see it make money," Steenbarger said.
And it can be very lucrative, with a programer typically making 10
per cent commission on the money his model generates, said Irene
Aldridge of Able Alpha Trading, a one-time quantitative specialist at
CIBC in Toronto who has a forthcoming book on the practicalities of
high-frequency trading and algorithmic strategies.
The best programmers can make tens of millions of dollars a year.
That was even the case during last year's financial crisis, as great
volatility offered both risks and opportunities for high-frequency
traders.
"It's a highly technical, mathematical game," Berkeley said. "They
are playing a very precise game of statistically estimating and
predicting over the next three to five seconds whether there is going
to be any liquidity in that stock and where it is. And how they can
take it without being seen and without leaving any tracks."
Low key and somewhat awkward, these introverted but brilliant traders
look up to James Simons, the Renaissance Technologies fund manager
known as the "King of the Quants."
A media-shy mathematics professor, the 71-year-old Simons has made
billions of dollars by making the right bets on technical trading
strategies. In January he will retire from his firm, which manages
$17 billion (£10.2 billion) in assets, but will leave an indelible
mark on the industry.
In fact, the Simons model has made "PhD" some of the most common
letters seen following the names of today's top traders. Expert
mathematicians, physicists, computer scientists, engineers and
economists have used technical skills to excel in trading. Among new
recruits, Wall Street experience isn't valued nearly as much as
programing aptitude.
"These are not your Harvard B-school grads, per se," said Robert
Olman, president of Alpha Search Advisory Partners, an executive
search firm for hedge funds and proprietary trading shops.
"They often have dual degrees, bachelors and masters. One degree is
going to be computer science, and the other degree might be financial
engineering, math, physics," he said.
Traders have discovered that mathematical techniques can help them
gain more control over their trades, said Berkeley. They hunt for
trading venues that give them the fastest trades at the best price
without exposing their strategies to rivals.
An obsession with milliseconds has led high-speed traders to focus on
"co-location," where trading shops try to place themselves as close
as possible to an exchange's data centers.
High-frequency trading shops that focus on options have sprung up in
Chicago, near the options exchanges, and in New Jersey, where trading
venues like BATS and Direct Edge are located and where the Nasdaq and
New York Stock Exchange house their data centers.
"High-frequency traders use the computer and the speed of the
computer to take control of the situation," said Pipeline's Berkeley.
"It's just like having a high-speed fighter airplane versus a slow-
speed one. If I can turn inside your turning radius, and if I'm
faster than you are, I can win every time."
The essence of algorithmic trading, Berkeley says, is to avoid
trading at a bad price. Traders get as much control as possible over
how to enter an order, cancel an order, change the size of an order,
or find out any other information that will help them stay ahead.
"It is all about converting the fact that you have very high speed
and very precise control of your order into an advantage," Berkeley
said. "If you don't get the trade you want, your order is canceled.
You don't sit there even for a nanosecond."
However, high-frequency traders' computer programs are not foolproof.
John Malitzis, vice president of market surveillance at the New York
Stock Exchange's oversight body, told a conference in September that
he has seen examples, both in U.S. markets and elsewhere, of computer
algorithms malfunctioning. He calls them "algos gone wild."
High-frequency traders are also often discreet and secretive.
Proprietary trading shops and banks spend millions developing complex
algorithm strategies and want to keep them in a black box well away
from their competitors.
"The social skills traditional traders have needed to serve clients
are disappearing," said Aldridge, herself an ex-trader at a "prop
shop."
"There was a lot more interpersonal communications on the trade
floor," she
said. "You see little of that at all anymore, because most of it is
by
computer."
And that can be a risk in itself, some say. While the computer
traders are more coolly analytical, proprietary shops have had to put
in control mechanisms to rein in the brilliant programmers who are
sometimes so immersed in their reams of data that they lose
perspective.
"They are so immersed in the market activity they don't really have a
panoramic (view)," Steenbarger said.
search: