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Wall Street Journal On The Systemic Threat Posed By Quants
- Barack Obama
- Beazer
- Cliff Asness
- Federal Reserve
- Finance Industry
- Flash Trading
- Goldman Sachs
- goldman sachs
- High Frequency Trading
- High Frequency Trading
- Housing Market
- Latency Arbitrage
- Main Street
- Meltdown
- NASDAQ
- New York City
- New York Stock Exchange
- Prop Trading
- Quant Trading
- SLP
- Sponsored Access
- Transparency
- Volatility
- Wall Street Journal
Nearly a year ago, Zero Hedge first brought broad public attention to the nebulous aspects of the dark and dirty underworld of the market, exposing the "second-tier" of privileged market participants, consisting of quant traders, high frequency trading, flash trading, sponsored access, co-location, latency arbitrage, Morgan Stanley's discussed-below PDT operation, and many other topics (check our Glossary for much more). In April, Zero Hedge wrote an open letter to the quant community, pleading for more transparency absent which the eventual result would be "larger, systematic problems at the largest, most sophisticated quant managers." Since April, the impact of market neutral quants has progressively declined, as factors, one after another, have failed, and market neutral indexes are probing multiyear lows (HSKAX). The question of who has stepped in to replace the whales' liquidity provisioning is still unanswered, although the explosion of small, inexperienced 3 man quant shops consisting of a math Ph.D. and two programmers, may be part of the answer. The integration of Goldman within the structure of the NYSE and other exchanges, may be another: at last check, Goldman is still a key component of the NYSE's SLP program, regarding which there is still barely any information, despite promises by NYSE representatives to the contrary (and with Goldman's prop operation potentially terminally crippled, the question of how extensively intertwined prop trading is with liquidity provisioning, will be a major topic going forward). Today, the WSJ's Scott Patterson takes advantage of the recent furor over quants and in extensive article promotes his new book "The Quants" in which "he suggests how this new breed of
mathematicians and computer scientists took over much of the financial
system—and the damage they inflicted in the 2007 meltdown." We are glad that, after nearly a year of writing about it, the topic of the market systemic threat presented by a small subcommunity of quantitative traders is finally emerging on the mainstream scene.
We present Scott's article in totality. We expect nothing less than the traditional choir of defenders of this increasingly more dangerous and stigmatized practice to emerge in full force. We, as always, welcome their conflicted perspectives.
How a swashbuckling breed of mathematicians and computer scientists nearly destroyed Wall Street
By SCOTT PATTERSON
On Thursday, President Barack Obama proposed new rules to curb a number of Wall Street's risky—and highly profitable—trading activities. One target: The secretive trading operations within banks that use large doses of leverage, or borrowed money, to make huge bets on the market. Wall Street says the regulations are unnecessary, and since the financial crisis struck, most banks have cut back on these trading outfits. But when the downturn first hit in the summer of 2007, several of them were among the first to suffer, and collectively they lost billions over a matter of days.
A small group of brainy math whizzes are emerging as the unlikely group who nearly brought down the finance industry. As WSJ's Scott Patterson reports, a group called "The Quants" developed complex systems to trade securities such as mortgage derivatives, which were at the heart of the crisis.
In his new book, "The Quants," Wall Street Journal reporter Scott Patterson suggests how this new breed of mathematicians and computer scientists took over much of the financial system—and the damage they inflicted in the 2007 meltdown.
At Morgan Stanley's investing powerhouse Process Driven Trading on Monday, Aug. 6, founder Peter Muller was AWOL, visiting a friend near Boston. Mike Reed and Amy Wong manned the helm, PDT veterans from the days when the group was nothing more than a thought experiment, its traders a small band of young math whizzes tinkering with computers like brainy teenagers in a cluttered garage.
On Wall Street, they were all known as "quants," traders and financial engineers who used brain-twisting math and superpowered computers to pluck billions in fleeting dollars out of the market. Instead of looking at individual companies and their performance, management and competitors, they use math formulas to make bets on which stocks were going up or down. By the early 2000s, such tech-savvy investors had come to dominate Wall Street, helped by theoretical breakthroughs in the application of mathematics to financial markets, advances that had earned their discoverers several shelves of Nobel Prizes.
PDT, one of the most secretive quant funds around, was now a global powerhouse, with offices in London and Tokyo and about $6 billion in assets (the amount could change daily depending on how much money Morgan funneled its way). It was a well-oiled machine that did little but print money, day after day.
That week, however, PDT wouldn't print money—it would destroy it like an industrial shredder.
The unusual behavior of stocks that PDT tracked had begun sometime in mid-July and had gotten worse in the first days of August. The previous Friday, about half a dozen of the biggest gainers on the Nasdaq were stocks that PDT had sold short, expecting them to decline, and several of the biggest losers were stocks PDT had bought, expecting them to rise. It was Bizarro World for quants. Up was down, down was up. The models were operating in reverse.
The market moves PDT and other quant funds started to see early that week defied logic. The fine-tuned models, the bell curves and random walks, the calibrated correlations—all the math and science that had propelled the quants to the pinnacle of Wall Street—couldn't capture what was happening.
At the time, few quants realized what was happening, but over the next few days a theory would emerge: The U.S. housing market was unraveling, leading to big losses in the mortgage portfolios of banks and hedge funds. One or more of those hedge funds needed to raise cash quickly to make up for the losses, and needed to sell assets quickly to do so. And the easiest-to-sell assets of all were stocks, those held in portfolios highly similar to quant funds across Wall Street.
The QuantsThe result was a catastrophic domino effect. The rapid selling scrambled the models that quants used to buy and sell stocks, forcing them to unload their own holdings. By early August, the selling had taken on a life of its own, leading to billions in losses. The meltdown also revealed dangerous links in the financial system few had previously realized—that losses in the U.S. housing market could trigger losses in huge stock portfolios that had nothing to do with housing. It was utter chaos driven by pure fear. Nothing like it had ever been seen before. This wasn't supposed to happen!
The quants did their best to contain the damage, but they were like firefighters trying to douse a raging inferno with gasoline—the more they tried to fight the flames by selling, the worse the selling became. Quant funds everywhere were scrambling to figure out what was going on.
Tuesday, the downturn accelerated. Applied Quantitative Research, the Greenwich, Conn.-based quant fund giant run by former Goldman Sachs Group whiz Cliff Asness, booked rooms at the nearby Delamar on Greenwich Harbor, a luxury hotel, so they could be available around the clock for stressed-out, sleep-deprived quants.
Authorities, meanwhile, had little idea about the massive losses taking place across Wall Street. That Tuesday afternoon, the Federal Reserve said it had decided to leave short-term interest rates alone at 5.25%.Investors on Main Street had little idea that a historic blowup was occurring on Wall Street. AQR risk-management guru Aaron Brown had to laugh watching commentators on CNBC discuss in bewilderment the strange moves stocks were making, with no idea about what was behind the volatility. Truth was, Mr. Brown realized, the quants themselves were still trying to figure it out.
Mr. Brown, who had joined AQR earlier that year, had been trying to get up to speed on the fund's systems to help manage its risk. He'd decided to stay in the office that Tuesday night and sleep on a small couch near his desk. He wasn't the only one. Near midnight, he stepped out of his office, eyes bloodshot from peering at numbers on a computer screen for the past 20 hours. The office was buzzing with activity, dozens of haggard quants chugging coffee, iPods plugged into their ears as they punched frantically on keyboards, unwinding the fund's positions in markets around the globe. It was a strange sight. The office was nearly as busy as it was during the day, but it was pitch black outside.
The carnage revealed a dangerous lack of transparency in the market. No one knew which fund was behind the meltdown. Nervous managers traded rumors by email and phone in a frantic hunt for patient zero, the sickly hedge fund that had triggered the contagion. Many were fingering Goldman Sachs's Global Alpha, the quant fund founded by Mr. Asness in the 1990s that had grown to massive proportions. But no one knew for sure.
At PDT on Tuesday, Mr. Muller kept ringing up managers, trying to gauge who was selling and who wasn't. But few were talking. In ways, Mr. Muller thought, it was like poker. No one knew who was holding what. Some might be bluffing, putting on a brave face while massively dumping positions. Some might be holding out, hoping to ride through the storm. And the decision facing Mr. Muller was the same one he confronted all the time at the poker table, but on a much larger order of magnitude: whether to throw in more chips and hope for the best or to fold his hand and walk away.
As conditions spun out of control, Mr. Muller was updating Morgan's top brass. He wanted to know how much damage was acceptable. But his chiefs wouldn't give him a number. They didn't understand all of the nuts and bolts of how PDT worked. Mr. Muller had kept its positions and strategy so secret over the years that few people in the firm had any inkling about how PDT made money. They knew it was profitable almost all the time. That was all that mattered.
That meant it was Mr. Muller's call. By Wednesday morning, he'd already decided. It was time to sell.
Walking downtown on Broadway that morning to Morgan Stanley's office through thick, sweaty crowds, Mr. Muller was growing impatient. Traffic in midtown Manhattan was jammed up like he'd never seen before. People swarmed the sidewalks, not just the usual tourists but businessmen in suits, nearly everyone jabbering frantically on their cell phones.
He'd just left his spacious apartment, located at the southwest corner of Central Park and 14 blocks north of Morgan's headquarters. There was no time to waste. The market would be opening soon. And he was worried the meltdown would continue.
Even nature seemed to be conspiring against him. Earlier that morning, a tornado had struck the city, hitting land shortly before the morning commute in New York City began in earnest. As quickly as the storm had rushed in, it cleared away, swirling into the Atlantic.
At Morgan's headquarters, Mr. Muller flew into the trading room. He flicked on his rank of computers with access to data on nearly every tradable security in the world. After a quick check of the market action, he checked PDT's internal gauge of gains and losses.
It was bad. This was the most brutal market Mr. Muller had ever seen. The U.S. housing market was melting down, causing huge losses at banks and hedge funds around the world. Stock markets were in turmoil. Panic was spreading. The entire system started to seize up as the delicate, finely wrought creations of the quants spun out of control.
PDT executed Mr. Muller's command that morning, dumping positions aggressively. And it kept getting killed. Every other quant fund was selling in a panicked rush for the exits. That Wednesday, what had started as a series of bizarre, unexplainable glitches in quant models turned into a catastrophic meltdown the likes of which had never been seen before in the history of financial markets. Nearly every single quantitative strategy, thought to be the most sophisticated investing ideas in the world, was shredded to pieces, leading to billions in losses. It was deleveraging gone supernova.
Oddly, the Bizarro World of quant trading largely masked the losses to the outside world at first. Since the stocks they'd shorted were rising rapidly, leading to the appearance of gains on the broader market, that balanced out the diving stocks the quants had expected to rise. Monday, the Dow industrials actually gained 287 points. It gained 36 more points Tuesday, and another 154 points Wednesday.
Everyday investors had no insight into the carnage taking place beneath the surface, the billions in hedge fund money evaporating. Of course, there was plenty of evidence that something was seriously amiss. Heavily shorted stocks were zooming higher for no logical reason. Vonage Holdings, a telecom stock that had dropped 85% in the previous year, shot up 10% in a single day on zero news. Online retailer Overstock.com; Taser International, maker of stun guns; the home building giant Beazer Homes USA; and Krispy Kreme Doughnuts—all favorites among short sellers—rose sharply even as the rest of the market tanked.
From a fundamentals perspective, it made no sense. In an economic downturn, risky stocks such as Taser and Krispy Kreme would surely suffer. Beazer was obviously on the ropes due to the housing downturn. But a vicious market-wide short squeeze was causing the stocks to surge.
The huge gains in those shorted stocks created an optical illusion: the market seemed to be rising, even as its pillars were crumbling beneath it.
There was a deceptive lull soon after lunchtime. But as the closing bell neared in the afternoon, the carnage resumed. Mom-and-pop investors watching the market make wild swings wondered what was going on. They had no way of knowing about the massive computer power and decades of quant strategies that were behind the chaos making a hash of their 401(k)s and mutual funds.
A source of the extreme damage Wednesday and the following day was the absence of some high-frequency statistical arbitrage traders, firms that use high-powered computers to trade rapidly in and out of stocks and can act as liquidity providers for the market.
As investors tried to unload their positions, the high-frequency funds weren't there to buy them—they were selling, too. The result was a black hole of no liquidity whatsoever. Prices collapsed. By the end of the day on Wednesday, PDT had lost nearly $300 million—just that day. PDT, it seemed, was going up in smoke. Other funds were seeing even bigger losses. Goldman's Global Alpha was down nearly 16% for the month, a loss of about $1.5 billion. AQR had lost about $500 million that Wednesday alone, its biggest one-day loss ever. It was the fastest money meltdown Mr. Asness had ever seen. He was well aware that if it continued for much longer, AQR would be roadkill.
And there was nothing he could do to stop it. Or so it seemed.
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LOL at the display ad on the left soliciting for "Hedge Fund Quant Job" resumes.
(i realize its a keyword / google adspace thing). Maybe I should apply.
at least click the ad for zh revvies.
i get a sick enjoyment out of clicking the never ending flow of COF ads. I must have hit them a hundred times over the past couple of weeks.
Gotta support. I can't live without ZH.
Also a thought. This banker Prop Obama business. How convenient it was that these CEOs were all in DC a week prior. I smell a distraction and then business as usual.
Hedge Funds and Primary dealers are but the handmaidens to a Fed whose foundation was seeded to protect the self-interest and fundamentally predatory functions of its fathers. They have become insinuated into profit-making without wealth-creating. They are trading on the accumulations of a past GREAT Untied States. Theirs is a mathematically assured derivation of gain built upon usury, fractional reservation, crushing interest, and fiat printing presses.
When zero long-term interest rates are embraced, AND a central bank OPENLY espouses monetization (check-kiting, welshing, fly-by-nighting), is there really ever any cure, or return to sanity?
Of course, you know the answer. It is but another sign and portent, as significant as blazing orbs, shifting earth, or great waves of the sea.
There can be no return to Happy Days. We have danced with the devil, and made him amourous therewith. He shan't be denied.
The ONLY wealth to be gained now in this slipping republic, is that wealth which the state shall surreptiously or by muscular suasion strip from the quickly diminishing fat-o-the-land. Hedge funds, paper traders, purveyors of the multiplicity of debt forms, in concert with a venal (and fearful) petty parliament will engage in all the time-worn means to procure reward where none was ever earned. Killing angels are they, rewarded for keeping a satanic figure ensconced with the illusion of power...and control.
They rob the treasury. They impoverish the virtuous--and by virtuous meaning those whose daily efforts are devoted to real improvement of this world and bestowing that good charity for price to their neighbors.
It is the perversion of a great endowment; it is the abuse of high office. Instead of making reward to those whose performance brings peace and pleasure, they divert substance for consumption by the sycophant, the court inveiglers, the genius intriguers. But never for the forlorn widow or orphan.
Soon the imbalance shall be made right. That which is crooked shall be made straight.
But not until bitter disgust provokes each soul (by core revulsion) to recognize and reject it. Then will equity again prevail.
Well put.
What a shame such a post should be anonymous.
Chiefly, it is anonymous because the author is himself the progenitor of all these crimes and misdeeds, being most familiar therewith and inspired by the constant torturous discourse of his own branded conscience to understand the higher nature of his own crimes and to bespeak them with all eloquence.
I, on the other hand, have no facility to discourse upon the punishment that shall befall him suddenly, as he sleepeth, a thief in the night brandishing the dull lead pipe of conscience full blown, for I have never committed any crime against my brother from whence to imagine such a clear perspective of the future.
My hands are free of blood.
I do, however, shake the dust from my angelic feet as I depart his residence.
Demons then there gather, a sinister red glow dancing upon the walls.
-TarkMwain
"Be careful about reading health books you
may die of a misprint" -Twain
+1
Install adblock, you douche
Poindexters + Hubris = Disaster
That was before my time at ZH. But let me tell you something I've been beating that drum fruitously for
a long time. I learned optionality in 1979 and have
been saying for awhile these models don't work. You
cannot apply quantum math to Wall St. Quantum math
is for hard sciences measurable reality. We are of
the soft science of behavioral finance. Well as the
world came crashing down and the models failed what now geniuses? Will you ever learn? I am told I'm very
bright tested top 2% in US but I donnot like to use my brain as a weapon of mass financial destruction. Next week should be interesting to say the least. Why? Where do
I begin?
The fundamental question is: Can math be applied in situations where human emotions are huge factor?
From the onset of the industrial revolution, math has been applied to calculate the strength of iron, the brittleness of steel at a certain temperature, the bearing capacity of a bridge, the velocity and tragetory of a spaceship etc etc.In all those situations, human emotions are a negligible factor.
However, to calculate the expected return on a mortgage back security, or the expected return on a CDS hedge or the return on an equity fund, math may serve a very limited purpose, since human emotions can wreck all calculations in a matter of hours.
Which begs the question: Is math a false god in monetory situations?
M. Nam
So you really think everyone will turn off their mainframes. I'm sorry Dave, I can't let you do that.
The problem isn't quantitative trading. The problem is that their algorithms were crap.
Algos do what algos do. But it's just herding and crowded trades when a large algo-wolf pack hunt with straight 130/30 and single factor models.
A seasoned trader could have seen what was going to happen. Nobody saw the 25 sigma whupping they got though.
Risk management dropped the ball because they didn't know what was going on and didn't have the moxie to find out.
The problem was a generation wishing to obtain wealth without production. The problem was an amazingly sophisticated form of distorting reality, of falling in love with mental models, of superb devices to disguise downside while magnifying unrealistically upside.
It was a problem of being seduced by the dark nature within man. That same nature which seeks to deprive unknown neighbors of their handiworks by violence. This time it was by preying upon their ignorance, instincts for greed, and fear that their intellectual capabilities were wanting.
Everyone wished that an efficient market was not just hypothesized. They wished the system would self regulate and drive the malefactor from the field, never to reappear.
It merely taught those malefactors greater subtlety. It taught them subversion by political corruption. It taught them a perfection in the arts of deceit. It rewarded their canny zero-sum game play.
It was the high art of the weevil, the gloat of corn canker, the satisfaction of a remora, the orgiastic success of a tape worm.
But the high-minded, if not dozy host has too late come to the realization of his condition.
No cure, no compress, no plaster brings relief.
Time to get busy making a small life out of Dying.
Man, write a book, if you haven't already.
I guess whether one sees quant trading as the "problem"
or not depends on what you consider a problem.
Turning the stock market into a casino is a problem from my perspective. That's what quant trading has done. It is primarily about tracking momentum and shifts, rather than the fundamentals of companies.
I say ban it completely and send those quant guys to Vegas.
An alternative is to end the publically-held-company model.
This means only having privately held corps.
I prefer the latter, though I think most people would prefer door number 1.
Are you serious?
How much do y'all wanna bet Paulson and Ben were on the other side of these trades?
I bet not. "The deepest sin against the human
mind is to believe things without evidence"-Huxley
dont forget Goldman's Global Equity Opportunity fund dropped 35% that week. the contagion slowed down on the following thursday, & on friday there was a huge bounce i n those factors. there was also another mini-unwind again about 6 or 7 trading days later. Ultimately, u saw a protracted bleed in the quant croweded value factors for the duration of 2007. ironically, 2008 ended up being a great year for value factors, starting off w/ a gift from Bernanke w/ his 75 bps after MLK, & another 50 bps a week later cut in the fed funds, causing a nice melt up in those factors, & powering through w/ the panic in the fall.
if someone can tell me how to post graphics, I can provide some charts of the those value factors to illustrate the magnitude of the contagion during that time
Yes, the last couple of days showed the same thing as well. When everyone is Selling the HFT Computers Sell as well. They are not there to support the Market just to trade it. HFT in my opnion just exasperates the move up or down as the Computers are Front running every Trade. So, when people are Buying they are Frontrunning and Buying ahead of them. When people Sell they Sell ahead of them pushing the Market even lower.
HFT Computers are not Market Makers they are just scalpers.
It used to be a Market of "TRADERS" now it is a Market of "TRADES". Computer Trades of course.
i am starting a Quant Fund with a souped up 386 and a Pentium processor, call it Super Nova.
Bright Flash and POOF! Black hole.
Who's in?....anyone?
It's not the quants. It's the crappy algorithms behind so many of them.
Just like to point out that MIT Technology Review did a great piece on this back in 2007 - first I heard about it. This article sounds remarkably similar to that one.
http://www.technologyreview.com/Infotech/19529/
Thanks for that link. That led me to this:
http://www.technologyreview.com/video/?vid=504
I didn't know that HFT LOWERS volatility.
Oh and i found this video too and all I can say is Are You Fuckin Kidding Me?
http://www.technologyreview.com/video/?vid=496
This is true under most conditions. A lot of HFT arbitrages (I didn't say "provides liquidity" so don't yell at me) around VWAP, and this arbitrage tightens the variance around VWAP. A corollary to this is VIX is lowered.
Under some illiquidity conditions, HFT chased and worsened a falling stock prices, and as a consequence accelerated the VIX explosion.
A lot of shops have more human traders tending the action now, who can presumably switch algo on a dime. In a sense they are the soul in the machines.
The key quote:
`As conditions spun out of control, Mr. Muller was updating Morgan's top brass. He wanted to know how much damage was acceptable. But his chiefs wouldn't give him a number. They didn't understand all of the nuts and bolts of how PDT worked. Mr. Muller had kept its positions and strategy so secret over the years that few people in the firm had any inkling about how PDT made money. They knew it was profitable almost all the time. That was all that mattered.'
Blame the geeks. Blame the algorithms.
Executive management oversight, accountability, responsibility? anyone?
selling vol IS profitable ....... most of the time
This is a bizarre story, Aside from the obviously sophomoric writing style, it appears that these guys (and, by extension, their mathematical models) didn't really have a great understanding of how stock markets work.
"there was plenty of evidence that something was seriously amiss. Heavily shorted stocks were zooming higher for no logical reason. Vonage Holdings, a telecom stock that had dropped 85% in the previous year, shot up 10% in a single day on zero news. Online retailer Overstock.com; Taser International, maker of stun guns; the home building giant Beazer Homes USA; and Krispy Kreme Doughnuts—all favorites among short sellers—rose sharply even as the rest of the market tanked."
Well, looking at the chart of Beazer Homes (BZH) for example: back in early Aug of 2007, BZH stock had already suffered a precipitous decline the months prior to Aug 7 (from $37.62 on May 23rd to $10.96 on Aug 6th).
Furthermore, the stock gapped down from a low of $18.58 on July 23rd to a high of $18.09 on the following day. At $10.96 on Aug 6th, it was sitting well below the 20-dma (and had been riding the lower Bollinger band for weeks, with hardly a bounce at all).
Now, I'm no expert at stock trading, but even I know that an oversold (and heavily shorted) stock that has a gap sitting nearly 68% above its current price is subject to a sharp short-covering rally...AT LEAST back to it's 20-dma (which was at about $18.25 at that time. Of course, it DID hit that price point (and was back down to $10 within a week). As I said, this kind of price movement should NOT be surprising for anyone who knows anything about price action in the stock market.
[As an aside...for any gamblers out there: BZH never did fill that price gap at $18.58 from July 23, 2007...it made it only to $18.42 on Aug 9th, then retreated and continued its slide to its current price of $4.10. A patient person interested in a highly speculative "investment" might do well to purchase a position in BZH for a possible move to eventually "fill the gap" at $18.58 (a potential gain of 458% from today's price). Sure, it might take a couple or several years...but, how long SHOULD it take to earn a 458% return? 39 million shares of BZH traded on Jan 7, 2010 at $5.09...surely SOMEONE bought some BZH with the prospects of making a killing on a longer-term bet.
Alternatively, one could buy the XHB at $14.95 today...and if it fills the gap at $28.85 (from that same day in July 2007), that would be a 93% gain. Hardly the "home run" that 458% would be...but it's an ETF, so more diversified (and it pays a 1% dividend]
I like the way you manly attacked thier sophmoric writing style. If you were a girl you would have talked about how they dressed and thier appearance. I think everything below that is pretty much from the shallow end of the pool but I didn't read it because well the shallow end of the pool is usually where all the warm piss ends up.
And if you were a woman you'd probably know
how to spell and the shallow end of the pool is
where you bob around as you can't swim.
Fellas, I feel you're both being misogynistic right in front of Marla, who can write and analyze you both under the table
and has been known to go shark hunting in the dark night ocean wearing only a thong carrying a primitive spear.
In other words, N*cc*hs Pullease.
-MobBarley
I know you are but what am I. :p
Given the domination of trading volume by quant driven HFT action it is amusing that there is even any discussion of Volume anymore. None of the TA volume considerations have any basis anymore because the activity is primarily noise.14
Traditionally "speculators" versus investors provided liquidity by speculating. As speculators they provide a balancing position to investors in that they did short sales for example but overall provide a point of view that balances by its differences investor side decisions. Speculators add liquidity taking positions and risk that often mirrors investors as a complimentary opposit view.
Quants saying they add liquidity, borrow from the notion a speculator adds liquidity, as if quants (since they are not investors) must be speculators. (Goldman Logic = they are morons tell em anything confuse em) But quants are neither, they are arbitrageurs around the bid ask spread and market manipulators.
The speed aspect of their technology gives them away. Rapid posting and withdrawal of prices only allows them to show a fake-out (front running) price in order to withdraw it before the littlest amount actually get traded and then sell the opposite position. Rapidly fake and preferably in small increments of price so their risk committment is minimized. Trading like this is not investing and its not speculating which assumes a position and thus assumes risk. What it is is virtually riskless making it virtually arbitrage which purely defined has no risk. If the cost of the one trade getting traded is considered a cost
of faking for the sunsequent profitable trades in fact these are "riskless trades."
Quants saying they add liquidity is a bold faced lie or they simply have no idea what they are doing or what to call it. Liquidity by showing 5 bid side prices withdrawing them when 1 gets hit and hitting the 5 new higher bids (following the notion from the last trade one has to bid higher) for a profit in the balance cannot be "adding liquidity." The one that got hit resembles liquidity but its the cost of manipulating the 5 following trades. Pretending to assume risk in one trade to manipulate 5 is manipulation and the alleged liquidity is not such but instead stolen money which actually removes liquidity from a market quite directly.
Quant double speak is only quant double speak which assumes we can't understand what they are doing because they confuse theft and dishonest manipulation (what they do) with something legitimate like assuming speculative risk. Because value investors and speculators use quants does not mean nickel and dime arbitrage quant traders are anything more than a third cateqory which the laws/rules of the market were written to prevent from participating in the market -manipulators.
Well Said
Not well said.
In a recent ZH article it described a quant trade unfiltered access blowing in thousand of prices "accidentally" blocking the trading in the stocks until close and "fixed" when the market "caught it" next day.
Consider a hypothetical scenario where the trader caught the error after ten entries which found matches and became valid trades...he would have to honor these trades. So there is a cost balance between honoring a mistake that trades versus letting the machine block trading making more errors and paying a fine less than the cost of honoring trades....
The stock market has no way to prove what happened without analysis of the software and possibly even a videotape of what the trader actually did. So one off a fine is levied and no punishment occurs.
But for a quant this one opportunity can be a cheap way to fix a costly mistake.
Saying its a crappy algorithm misses the point. The quants create the algorithm so there is nothing behing an algorithm but a quant. And an algorithm is not "behind a quant..."
Its natural arbitrage quants are blind sided when markets really move in a big way since they never traded as investors, traded as speculators or even talked to a broker or counterparty.(they have no color or someone to discuss a judgment with if they needed to...)
Those of us who have voice brokered have waited and expected that when relatively quiet markets or markets moving up for a long time based on erroneous valuation would eat arbitrage quants alive since they have no experience with a "real" market and they came to represent in numbers a larger part of the market trading pool.
Like our children that think what they experience on video game screens and television is the reality, quants similarly (or the same recently children) come to believe their safe riskless virtual trading is the reality of a real market which it is not.
In this sense they are risky to have around as they will panic and pile on to a crash instead of stepping aside and out.
Its natural arbitrage quants are blind sided when markets really move in a big way since they never traded as investors, traded as speculators or even talked to a broker or counterparty.(they have no color or someone to discuss a judgment with if they needed to...)
Those of us who have voice brokered have waited and expected that when relatively quiet markets or markets moving up for a long time based on erroneous valuation would eat arbitrage quants alive since they have no experience with a "real" market and they came to represent in numbers a larger part of the market trading pool.
Like our children that think what they experience on video game screens and television is the reality, quants similarly (or the same recently children) come to believe their safe riskless virtual trading is the reality of a real market which it is not.
In this sense they are risky to have around as they will panic and pile on to a crash instead of stepping aside and out.
Quants with algos running high are the industrial robots of the financial industry. They charm the socks off management in early bubble phase as they prune experienced, high nominal cost humans. The rub that the likes of MER, BSC and LEH being short-term thinking whoremasters or pimps fail to appreciate is that it's all good in a world of sufficient liquidity, and the market quants have no ability to measure its sudden withdrawal. That is the human factor which is coming from the other side of the logical brain, and responsible for survival of the fittest. The large point here is that quants need high liquidity AND high-leverage to win the little heads of financial managers, but when that liquidity to float their boats or their equal signs run aground, at the point of panic inflection and liquidity crashes, leverage skyrockets and the house-of-cards collapses. Without bubbles, there is little but grinding out 'steenths and living by knowing where the bones are buried. All hail the greater fool, who lusts when I fear, to take the other side of my trade.
embarrassing post for zh. and please, AQR?
HuffPo Front Page Headline
KRUGMAN DENIES INTEREST IN FED CHAIR
http://i46.tinypic.com/23iuwyg.jpg
(it links to Simon Johnson's very left of left blog as in this is probably a trial balloon being floated by Axelrod to see if the base rallies around that name )
Unless I'm mistake, the nominee has to already be a member of the Fed to even be considered for Chair.
I don't understand what the problem is here. I'm not defending quant trading. You make money, you lose money. Seems to me the market makers did a good job of managing their book. I'm sure other traders and speculators made money during this period. I was short at the time, but shorted early and held on through the 2007 top and beyond. So some speculators got caught on the wrong side of the market or got squeezed one way or another. I view what they were doing as speculation, but they may have thought they were hedged.
I looked at the 2007 Dow 30 closes -
July 19 14000
Aug 16 12850
October 9 14160, then down from there
So quants lost a lot of money in a short period of time. It appears they also made a lot of money over time according to the story.
I'm reminded of a quote from several decades ago. Someone was asked about another person's trading or market timing success. His response was something like - As soon as people think they've uncovered the key to the market, the locks are changed. Seems like this is what happened to the quants. Isn't the first time, won't be the last time.
So...This is what it has come to.
Our lives managed by computers.
I thought the Matrix was a good movie but this is some next level real world shit.
> That Wednesday, what had started as a series of bizarre, unexplainable glitches in quant models turned into a catastrophic meltdown the likes of which had never been seen before in the history of financial markets.
There are literally hundreds of years of more catastrophic market moves to study.
It is quite possible that the relatively new quant funds discussed in the article had never operated during a "catastrophic meltdown" like that before, but there is absolutely nothing unique about the 2007 market moves when compared against the long history of financial speculation and folly.
Charles Kindleberger and Robert Aliber in their book "Manias, Panics and Crashes" put the top ten at:
1636 - Dutch Tulip Bulbs
1720 - South Sea
1720 - Mississippi
1927-1929 - Burst of US bubble
1970s - Mexico and other developing country loans
1985-1989 - Japanese real estate and equities
1985-1989 - Nordic real estate and equities
1992-1997 - Thai, Malaysia, Indonesia... real estate and equities
1990-1993 - Mexican foreign investment
1995-2000 - NASDAQ
Edward Chancellor in his excellent book "Devil Take the Hindmost" I think would produce a somewhat different list of the top 10.... but I don't think anyone with a good grasp of the history of speculation and financial markets would put 2007 into a class all of its own.
In terms of damage to hedge funds from all being on the same side of a series of trades gone bad (as compared against the funds deployed at the time), I'd bet that LTCM and the fallout from the Russian debt default caused more pain.
A quote from a meeting in 2006--the view Central Park: the credit rating agencies' models do not work and they do not know they do not work---but we do.
Irene Aldridge, managing partner, Able Alpha Trading Ltd, and author of the new book "High Frequency Trading: A Practical Guide to Algorithmic Strategies and Trading Systems".
http://watch.bnn.ca/clip214831#clip214831
"The carnage revealed a dangerous lack of transparency in the market. No one knew which fund was behind the meltdown. Nervous managers traded rumors by email and phone in a frantic hunt for patiented zero, the sickly hedge fund that had triggered the contagion."
The above was from the article above. Could it be that Zero Hedge is the same one they were all looking for?
Was well worth reading, and perhaps I'll check out the book if it makes it to the e-books list sometime.
My guess is it was Goldman, recognizing the jig was up on housing, then taking out short positions while dumping at the top and spreading rumors far and wide.
"The financial system nearly collapsed because smart guys had started working on Wall Street.”You guys need to help me out with this since I'm relatively new. The setting and premise has changed, but doesn't this plot sound familiar to that of Long Term Capital Management that I learned about in undergrad?
tyler, u guys eve see a tick in a cow's ass? thats what you are to GS and the larger financial world. Me likes!!!!!
What we learned from the past is that as long as the system was working properly, the Quaints were considered Whizzes. When the system failed, the whizzes were whizzing in their pants.
Ever been in a supermarket when the computers at the checkout counter stop working? Try handing the clerk a $20 dollar bill for a $17.35 order. Its funny as all hell watching them trying to figure out your change. Not much different from those Quaints trying to figure out WTF was happening.
lol
Is it part of a move to cashless society?
The absence of cash will encourage the barter system, and as every well educated human being knows the natural evolution of a barter system results in a commodity based currency which eventually will be gold and/or silver! Once people will get used to using gold and silver as mediums of exchange the demand for the precious metals will skyrocket and their price will go through the roof, and that is before people will start to look at them as a store of value. A cashless society will kill the fiat paper system http://israelfinancialexpert.blogspot.com/2010/01/if-we-move-to-cashless-society-it-will.htmlThe new currency will be toilet paper and whiskey. I have accumulated large quantities of both.
For those who have embraced the second coming of Volcker and rebirth of Obama you may want to consider this commentary from NC:
Quelle Surprise! Proposed Restrictions on Proprietary Trading are a JokeWell, shit happens. Funds selling stocks to offset losses in other securities? What else is new. It's called liquidation. Raising capital. Don't think it's a good thing that the bigger players have the entire world of stock markets, bond markets, commodities, currencies, and other stuff all linked together in massive intertwined trades. That's probably why, since March 2009, there has been a nearly perfect correlation between the fall of the US Dollar, the rise of the Euro, the rise of commodities, the rise of all stock markets.
However, with US politics and spending out of control, and the Euro looking frayed at the edges, I wouldn't want to be a quant these days. I suspect things have just started to unravel for the quants this past week.
As a little guy, you have two choices. Be like Buffett, buy at a reasonable price and hold on for a long time and let the algos do their thing, or, also be like Buffett, and buy the periodic crashes, and only the crashes.
Missed out in March 2009? I suspect patience will be rewarded.
One problem is this. In between the crashes prices are pushed artificially high for long periods of time. Meaning the average investor over pays for stocks because the market is run up and stays up artifically. Then crashes again. If you dollar cost averaged into the market the past ten years you were probably crushed. Not to mention the invisible loss we holders of US Dollars took as the currency was devalued versus the Loonie, Real, Euro, Aussie, Swiss Franc, etc.
I'm hoping for a redux of 2007-2009 to convert dollars into foreign currencies. Apparently one component of the massive global algo trade is to short the dollar and go long about everything else. During the periodic unwinds of this trade the dollar shoots up, and everything else collapses. Missed it the first time, won't the next.
Hard not to like the Aussie on a pullback.
You should load up on greenbacks and follow the run up in strength in the next couple of quarters. You can do this in preferance to holding PM's and watching them go down a tad while the greenback does it's mock victory dance.
Ever seen a well built crack addict shot 5 times in the back? They do the same thing. They dance about like they're superman and invincible and then they keel over dead.
Not that I've seen such a thing but I have a vivid imagination.
What is quantitative easing? QE is hyperinflation.
The process of printing money and using it to 'provide liquidity' to the markets , in other words, to purchase stocks, bonds, MBS et al is one and the same as 'artificially elevating prices of otherwise hyper deflationary paper'.
Crack addicts tend to overdose because they keep thinking that 'just one more hit' will finally put them on that elusive plateau of sheer ecstasy that always seems right around the corner. QE is the same thing. The subtle tipping point of obtaining price stability versus popping over into a hyper inflationary free fall of epic proportions will be overridden like a speed bump in a parking lot by a car populated by drunk stoned teenagers carousing in dad's 'borrowed' 1972 Pontiac GTO.
-MobBarley
Better start a Quant Fund with a cluster made of FPGAs. On the palm of your and you have computing capacity 1000x an average 3GH machine. Not to speak that you will have your network stack implemented entirely on hardware so your network packet latency will be unique among the market players. But remember to collocate this hardware with the exchange or otherwise you will be in a huge disadvantage. Of course this is an engineering advice ... what you will run on this potential money collecting machine is totally other issue ...
Long story short: yet another journalist with no clue what he's talking about. Same bashing happened last year, with ppl blaming David Li for the CDS meltdown... Give people whose math knowledge ends with linear regression in Excel anything more complicated - and it's equivalent to granting a monkey access to machine gun.
RTFM - I wonder whether any of them ever encountered this phrase?
Read the book