/Quantitative Hedge Funds: Wall Street’s Own Mt. Gox Willy Bot(s)?

Quantitative Hedge Funds: Wall Street’s Own Mt. Gox Willy Bot(s)?

Willy Bot in Human Form, former Mt. Gox CEO Mark Karpeles

The Wall Street Journal published an article on Tuesday, the gist of which was that computerized trading by quantitative hedge funds is to blame, if blame is to be assigned, for the downturn in the overall market. Leave out a geopolitics that might as well be alien to anyone who didn’t just enter the workforce. Leave out alternative investment opportunities the globe over, including cryptocurrencies. Leave out everything: just blame the terminator bots.

According to the Christmas-day article, just under 30% of all trading on Wall Street is conducted via computerized algorithm, which in Street Speak is “quantitative hedge funds,” and additional culprits are “passive funds, index investors, high-frequency traders, market makers, and others who aren’t buying because they have a fundamental view of a company’s prospects […]”

Neal Berger, who is in charge of Asset Management at Eagle’s View, an NYC-based fund, told the Journal:

The speed and magnitude of the move probably are being exacerbated by the machines and model-driven trading. Human beings tend not to react this fast and violently.

Parallels With Bitcoin’s Mt. Gox

It’s convenient to blame the trading bots when things go haywire. It’s rare to hear people loudly crediting them when things go well for the exact same reason. There’s a measure of groupthink in algorithms used because many of them are designed by the same people or with the same trading strategies in mind.

When companies see their stocks rise or cryptocurrencies get pumped 10s or 100s of percent upwards, no one complains. It’s when the bots perform as expected and take profit, often en masse, which prompts downward pressure, that people get itchy and start to ask questions about bots.

Despite the overwhelming human malfeasance that was taking place at Mt. Gox, a common anecdote of the day, especially before all the facts about MagicalTux Mr. Mark Karpeles got out, was that a rogue trading bot dubbed Willy was all to blame. Willy traded coins that didn’t exist. Willy did this. Willy did that.

There’s not much hope for a future which peacefully integrates artificial intelligence if it’s not decided in the present that whosoever uses – not creates or even necessarily owns – the technology is responsible for the outcome of its use.

If your robot freaks out and kills your neighbor’s dog, you’re to blame. If you entrust billions of capital to a trading bot and a rival bot eats your lunch, you’re also to blame. And of course, as was the case with Mt. Gox, if a trading bot continues to pump the price of bitcoins which have disappeared from your custody in some strange effort to preserve your position as the primary liquidation portal for a new wave of financial technology, then you are likely going down in history as a villain.

But here’s the real kicker with the editorial slant that WSJ placed on quant firms: they specifically imply that there’s no real research involved.

Today, when the computers start buying, everyone buys; when they sell, everyone sells.

In fact, AI can asses deeper information about companies, too. Overall, humans are able to tweak the decisions made by bots. It’s not purely based on numbers, although as the article points out, momentum plays a more pronounced role when decisions are automated.  However, if it were quite so simple as all that, it would be easy to combat from a human perspective.

This is to say: if quantitative trading firms were so irresponsible as to use no human data or “news” in their decisions, it’d be relatively trivial for fully-human-powered firms (which don’t actually exist) to leave them holding the bag in ways that counted. Arguably, they’d be doing so on such a regular basis that bot-trading would be disincentivized rather than a major area of interest across financial technology firms.

Plenty of people called the 2013 bubble in Bitcoin and had there been more margin trading available, there’d have been a lot more millionaires minted. People called last year’s insanity and made out handsomely both selling at the top and shorting Bitcoin, no matter their personal feelings toward it.

Business is war and business is good. There is no aspect of the modern market which does not rely on some kind of technology, and in the future it is unlikely that a mere 30% of firms will be using bots.

In all fairness to the Journal‘s Gregory Zuckerman, Rachael Levy, Nick Timiraos, and Gunjan Banerji, who authored the article to which this author responds, they did reach out for people who understand there are multiple other elements at play.

Yet, the premise of their article is arguable to this reporter — “an unprecedented trading herd that moves in unison.” The author argues that the only real difference is the speed at which they move in unison. After all, bag holding is rarely the ideal position to be in short-term. Very rarely. Nevertheless, the authors go out of their way to state that trading bots are not at fault, and for this they deserve credit:

The robots didn’t trigger the decline, of course. But they devoured a stew of red signals in the second half of the year.

At time of writing the Dow Jones had posted a more than 5% post-Christmas recovery, its largest single-day percentage gain since 2009 and its largest point gain ever. Perhaps it can be called “The Fintech Effect.” If bots are the cause when the market goes bad, or even just accelerates in the direction it’s already heading, it stands to reason they’re to credit when things start to shift for the better. Also: if all the claims about quant firms are true, then it’s impossible for the day’s gains to have happened without their participation, either.

Featured image from Shutterstock. Karpeles’ photo from Bitcoinwiki.org.

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