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"We're All Dr.Evil Now"
Submitted by Ben Hunt via Salient Partners' Epsilon Theory blog,
DIY’s newest frontier is algorithmic trading. Spurred on by their own curiosity and coached by hobbyist groups and online courses, thousands of day-trading tinkerers are writing up their own trading software and turning it loose on the markets.
Interactive Brokers Group actively solicits at-home algorithmic traders with services to support their transactions. YouTube videos from traders and companies explaining the basics have tens of thousands of views. More than 170,000 people enrolled in a popular online course, “Computational Investing,” taught by Georgia Institute of Technology professor Tucker Balch. Only about 5% completed it.
– Wall Street Journal, "Algorithmic Trading: The Play at Home Version" August 9, 2015
London day trader Navinder Sarao has been formally indicted by a U.S. federal grand jury on charges of market manipulation that prosecutors say helped contribute to the 2010 "flash crash," according to a Sept. 2 court filing made public on Thursday.
The Justice Department first announced criminal charges against Sarao in April and is seeking to have him extradited to the United States to stand trial.
Sarao is accused of using an automated trading program to "spoof" markets by generating large sell orders that pushed down prices. He then canceled those trades and bought contracts at lower prices, prosecutors say.
– CNBC, "US Federal Grand Jury Indicts 'Flash Crash' Trader" September 3, 2015
Anxiety in the industry surged last week after Li Yifei, the prominent China chief of the world’s largest publicly traded hedge fund, disappeared and Bloomberg News reported that she had been taken into custody to assist a police inquiry into market volatility. Her employer, the London-based Man Group, did little to dispel fears, declining to comment on her whereabouts.
Ms. Li resurfaced on Sunday and denied that she had been detained, saying that she had been in “an industry meeting” and “meditating” at a Taoist retreat. But many in the finance sector are unconvinced.
– New York Times, "China's Response to Stock Plunge Rattles Traders" September 9, 2015
I’ve written several Epsilon Theory notes about modern market structure (“Season of the Glitch”, “Fear and Loathing on the Marketing Trail, 2014”, “The Adaptive Genius of Rigged Markets”, “Hollow Men, Hollow Markets, Hollow World”), all of which have been very well received. I’ve also written several Epsilon Theory notes about Big Data and non-human intelligences (“Troy Will Burn – the Big Deal about Big Data”, “First Known When Lost”, “Rise of the Machines”), all of which have generated a yawn. This divergence in reader reaction has puzzled me, because it seems so obvious to me that the issues are two sides of the same coin. So why can’t I communicate that?
It’s only over the last few days, after listening to old-school luminaries like Leon Cooperman and Dick Grasso rail against systematic investment strategies, index derivative hedging, and algorithmic market making as if they were the same thing (!) … it’s only after reading press stories that praise the US indictment of Navinder Sarao, the London trader who supposedly triggered the “Flash Crash” from his home computer, but condemn the Chinese detention of Man Group’s Li Yifei as if they were different things (!) … it’s only after seeing 500 commercials for “DIY trading platforms” on TV today as if this were a thing at all (!) … that I think I’ve finally figured this out.
We’re all Dr. Evil today, thinking that one million dollars is a lot of money, or that one second is a short period of time, or that we are individually smart or capable in a systemically interesting way. We use our small-number brains to make sense of an increasingly large-number investment world, and as a result both our market fears and our market dreams are increasingly out of touch with reality.
There are a million examples of this phenomenon I could use (including the phrase “a million examples” which, if true, would take me a lifetime to write and you a lifetime to read, even though neither you nor I considered the phrase in that literal context), but here’s a good one. A few months ago I wrote an Epsilon Theory note on the blurry distinction between luck and skill, titled “The Talented Mr. Ripley”, where I pointed out that it was now quite feasible with a few million dollars and a few months to build a perfect putting machine, one that would put every professional human golfer to shame. Judging from the reader emails I received on this, you might have thought I had just said that the world was flat and the sun was a big candle in the sky. “Preposterous!” was the gist of these emails – sometimes said nicely and sometimes (actually, most of the time) not so nicely – as apparently I know nothing about golf nor about the various failed efforts in the past to build a mechanical putting device.
Actually, I know a lot about these mechanical putting devices, and to compare them to the non-human putting intelligences that are constructible today is like comparing Lascaux cave art to HD television. It’s relatively child’s play to build a machine today that can identify and measure the impedance of every single blade of grass between a golf ball and the cup, one that measures elevation shifts of less than the width of an eyelash, one that applies force within an erg tolerance that human skin would interpret as the faintest breeze. That’s what I’m talking about. Do you know how the most advanced surreptitious listening devices, i.e. bugs, operate today? By measuring the vibrations in the glass window of the room where the conversation is taking place and translating those vibrations back into the sound waves that produced them. That’s what I’m talking about. Now replace “blades of grass” with “individual stock trades”. Now replace “conversation” with “investment strategy”. Arthur C. Clarke famously said that any sufficiently advanced technology is indistinguishable from magic. Do you really think we bring to bear less powerful magic in markets with trillions of dollars at stake than we do in spycraft and sports?
And let’s be clear, the machines are here to stay. They’re better at this than we are. The magic is in place because the magic works for the people and institutions that wield the magic, and no amount of rending of garments and gnashing of teeth by the old guard is going to change that. Sure, I can understand why Dick Grasso would suggest that we should go back to a pre-Reg NMS system of human specialists and cozy market making guilds, where trading spreads were measured in eighths and it made sense to pay the CEO of a non-profit exchange $140 million in “retirement benefits.” And I almost sympathize with the nostalgic remembrances of a long list of Hero Investors recently appearing on CNBC, pining for a pre-Reg FD system of entrenched management whispering in the ear of entrenched money managers, where upstart quants knew their place and the high priests of stock picking held undisputed sway. But it ain’t happening.
And let’s also be clear, the gulf between humans and machines is getting wider, not narrower. Even today, one of the popular myths associated with computer science is that non-human intelligences are brute force machines and inferior to humans at tasks like pattern recognition. In truth, a massively parallel processor cluster with in-line memory – something you can access today for less money than a junior analyst’s salary – is far better at pattern recognition than any human. And I mean “far better” in the same way that the sun is far better at electromagnetic radiation than a light bulb. Much has been made about how robot technologies are replacing low-end industrial and service jobs. Okay. Sure … I guess I’d be worried about that if I were working in a Foxconn factory or a Bay Area toll booth. But far more important for anyone reading this note is how non-human intelligences are replacing high-end pattern recognition jobs. Like trading. Or investing. Or asset allocation. Or advising.
The question is not how we “fix” markets by stuffing the technology genie back into the bottle and we somehow return to the halcyon days of yore where, in Lake Wobegon fashion, all of us were above average stock pickers and financial advisors. No, the question we need to ask ourselves is both a lot less heroic and far more realistic. How do we ADAPT to a market jungle where human intelligences are no longer the apex predator?
I’ve got two sets of suggestions, depending on whether you see yourself as a trader or an investor. It’s a lot to digest, so let’s look at traders in the balance of this week’s note and at investors next week.

Every trader who ever lived believes that, like the Bradley Cooper character in “Limitless”, he or she has a recipe for grandeur. It doesn’t matter whether they find that recipe in prices or volumes or volatility or spreads or any other aspect of a security, all traders have an internalized pattern recognition system that they believe gives them a persistent edge. Most of them are wrong.
In modern large-number markets, any trading strategy based on naïve inference is certain to have zero edge, zero alpha. By naïve inference I mean selecting a strategy based solely on the econometric fit of a time series data matrix to some market outcome like price change. It’s a trading strategy that works because … it works. There’s no “why?” answered here, and as a result the strategy is certain to be derivative, non-robust, and quickly arbitraged. Or to put it in slightly different terms, whatever purely inductive trading strategy you think gives you an edge is already being used by thousands of non-human intelligences, and they’re using the strategy far more effectively than you are. To the degree a naïve inference strategy works at all, you’re just tagging along behind the non-human intelligences, picking up their crumbs.
What trading strategies have even a theoretical possibility of edge or alpha? Here are two.
Possibility 1: Find a market niche where your counterparties are non-economic or differently-economic market participants – like an oil futures market where a giant, lumbering integrated oilco seeks to hedge production, or where a sovereign wealth fund looks for inflation protection (Remember those happy days when giant allocators addressed inflation concerns in commodity markets? Me, neither.) – and scalp a few dimes by taking advantage of their very different preference functions. Traders who pursue this type of strategy have a name in biological systems. They’re called parasites. I call them beautiful parasites (see the Epsilon Theory note “Parasite Rex”), because they capture more pure alpha than any strategy I know.
Possibility 2: Find a market niche where you understand the impact of exogenous signals like news reports or policy statements on the behavioral tendencies of other human market participants, in exactly the same way that a good poker player “plays the player” as much as he plays the cards. These market niches tend to be sectors or assets that are driven less by fundamentals than they are by stories – think technology stocks rather than industrials – although here in the Golden Age of the Central Banker it’s hard to find any corner of the capital markets that’s not driven by policy and narrative. The game that these traders have internalized isn’t poker, of course, but is almost always some variant of what modern game theorists call “The Common Knowledge Game”, and what old-school game theorists like John Maynard Keynes called “The Newspaper Beauty Contest”.
What do these two examples of potentially alpha-generating trading strategies have in common? They operate in a world that a non-human intelligence – which is effectively a super-human inference machine – can’t figure out. Today’s effective alpha-generating trading strategies are based on a game (in the technical sense of the word, meaning a strategic interaction between humans where my decisions depend on your decisions, and vice versa) where you can have very different outcomes from one trade to another even if the external/measurable characteristics of the trades are identical. This is the hallmark of games with more than one equilibrium solution, which simply means that there are multiple stable outcomes of the game that can arise from a single matrix of descriptive data. It means that you can’t predict the outcome of a multi-equilibrium game just by knowing the externally visible attributes of the players. It means that the pattern of outcomes can’t be recognized with naïve (or sophisticated) inference techniques. It means that traders who successfully internalize the pattern recognition of strategic behaviors rather than the pattern recognition of time series data have a chance of not just surviving, but thriving in a market jungle niche.

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i need to take some more acid and read this again
You will end up turning off your computer and walking outdoors.
I have walked across the surface of the sun. I have witnessed flash crashes and quote stuffing so fast they can hardly be said to have occurred at all. But you are just a man. The worlds smartest man poses no more threat to me than does its smallest termite.
On the other hand, the FED can and will destroy us all.
We so need Dr. Manhattan on the side of the average guy.
But don't call me sonny.
except when you really look close you notice, its not the dinos, elephants, whales, tigers or any of the biggest and baddest that rule the world. It is the termites and the bacteria and the virus that ultimately win. Be a virus.
I love this guy's articles.
It validates my own personal thesis. If you don't won't to get conned in the "Greatest Con Of Them All" then don't play the game.
I have never owned stocks. or bonds. or munis or any of that completely useless shit. I am not worried in the least about "Skynet" being a better stock trader, hamburger maker, overlord or lover.
I....do....not....play.....the.....game.
This guy proves that he is too smart by half. Indeed intelligent. But no wisdom what so ever. Or....what wisdom he has is useless in the real world. Not the Financial Matrix he is trapped in. And....it most certainly is a trap.
If he were truly as smart as his writing seems to make himself out to be, or more importantly, wise....he would have already cashed his considerable stash of chips in and bought some land, near water, either a lake or stream and started farming.
But he can't. He's addicted to the "GAME". Therefore, he feels like his duty and his service is best rendered by mind fuck articles like the one he just wrote. On how best to adapt to the "Game".....to the ever evolving CON .
https://www.youtube.com/watch?v=Lr2iDWQSwsI
LOL ! Nice.
But as I have learned all too well......love can be the greatest CON of them all. But....some gambles are worth it.
I hear ya....the song kinda put me in all kinds of places...play the game, for love it might be worth a chance, but playing the zionist banker game is not worth it.
Watch how brave men fight and die for their right to be free.
If you think that is evil, fuck you.
Just focus on value and trade futures where there's a single exchange. Markets are simply trying to correctly value something. That's what the machines are doing 90% of the time. They are incredibly good at that. So do it with them. In many ways they've actually made the markets easier to read.
Rick Santelli you still taking cigarette breaks outside Ceres? Lol
Ben Hunt ?
I thought we'd left you on Treasure Island behind the stockade!
Howdidyagetoutofthar?
Ben got his Gunn of evil now!
Surrender Dorothy!
Wait until there is something like 100% alignment and then go theother way.
Oh and maybe scream "Fire" to help goose things along.
Maybe this new technology will alleviate the "need" to drop barrel bombs in civilian areas.
A lot of stick seems the only way to get Sunni societies to stay cohesive.
Did Saudi Arabia have their latest crucifixion yet?
Machines are fast not smart. Garbage in garbage out.
Software can be smart though. As for GIGO, what if it's not garbage going in? What if it is the latest, most accurate data, even processed on a high-speed (dumb) machine?
I'll tell you. It is the end of human competitiveness in any area in which any signiificant volume/number of these things exist.
Computers are much faster than humans, but they're not any smarter than the humans who programmed them.
How about not walking into the casino in the first place?
It's full of machines, marks, and gambling addicts.
There is no "market" nor "investment".
30-1 on double sixes.
Indifference The most pernicious and worst kind of evil there is!
There's not enough intelligible nonsense in this article to permit a comment.
I think this leads us all to think about what the "market" actually is and it's purpose. I believe that the reason for trading got lost and now it's just a huge burden on society hiding the fact that there are a lot of intelligent but useless eaters on the planet. History proves that mother nature, God or whatever you want to call it has a recipe for levelling the playing field every now and then.
Best response so far. +1000
Everything is a gamble. But then there is just useless gambling just for the thrill of it....or some useless fear that if you don't play the game, the people who play the game will run you over.
This guy is in that category. Means well.....but that non sense he just wrote just proves my point. If you have to think that hard how to grift a few scraps from the Masters of the Universe's table, it's time to cash in, forget about the thrill of the game and detox.
In other words.....this guy is addicted. And he needs rehab.
fractally dynamic
at least we can imagine that there is something bigger and more complex out there/in here than what we currently know how to imagine.
stuff doesn't stay still long enough for people to say hi to it, i guess.
I'd rather go to church than read this article.
I didnt give you a down, but wtf? go to church? lol to ya but how about going fishing or enjoying the country? I do know that going to church is the last place you will find Jesus lol...its true...Or, as I am doing today, I am listening to Queen on youtube....I dont care what they say about Freddie Mercury, I have been an avid musician since a little child, and Freddie is a legend...he makes michael jackson look like a kindergarten first day.
That's why I love shopping at Cabelas. I have never had to battle a single bot or shoot even one computer while purchasing more guns and ammo. Not all investment markets are dominated by the machines ......
You just have to be smarter than the average bear....or deer....or fish.
Does Tyler read my posts? I posted this video here about 2 weeks ago...lol, thanks Tyler
And the dice can be loaded by HFT. So it's not just a case of equal probability gambling outcomes.
Everyone still gets managed and prodded into a rigged game ... the skim is just more predictable.
In the end all HFT is ever going to be is front-runners front-running front-runners front-running actual investors. There is nothing smart about it, we are collectively stupid to setup markets which make it possible.
hft is a euphamism - how that term ever came to be accepted is baffling to me? what they are (/ALL they actually are) is low-latency frontrunners.
"The details of my life are quite inconsequential... very well, where do I begin?
My father was a relentlessly self-improving boulangerie owner from Belgium with low grade narcolepsy and a penchant for buggery. My mother was a fifteen year old French prostitute named Chloe with webbed feet.
My father would womanize, he would drink. He would make outrageous claims like he invented the question mark. Sometimes he would accuse chestnuts of being lazy. The sort of general malaise that only the genius possess and the insane lament.
My childhood was typical. Summers in Rangoon, luge lessons. In the spring we'd make meat helmets.
When I was insolent I was placed in a burlap bag and beaten with reeds- pretty standard really. At the age of twelve I received my first scribe. At the age of fourteen a Zoroastrian named Vilma ritualistically shaved my testicles. There really is nothing like a shorn scrotum... it's breathtaking- I highly suggest you try it."
"Her [Li Yifei's] employer, the London-based Man Group,"
LOL. Man Group spun off its financial arm in 2007. They called the new business MF Global.
This is what I took from the article:
If you can't dazzle them with brilliance, then baffle them with bullshit.