Gambling with Free Markets

Posted by: on Oct 27, 2014 | No Comments

tradingfloorFinancial and derivative trading is an interesting but violent game, full of love, fear, greed, loathing and ecstasy. There you go, I have owned up, and if your still wondering, it is emotional.

When I started in the City of London, apart from all the fun and learning, I was most impressed by a pervasive rule, that “your word was your bond”. Deals were done with counter parties who you may not have personally known, but when the phone went down and the ticket written up, you knew the deal was done. Your word was your bond, and by extension your firm’s word, was coveted at all costs. To rescind on a deal was infinitely more costly than the deal itself and consequently it did not happen. This principle of trust was honourable, good and tremendously impressive and was carried over into everyday dealings. It remains with me to this day.

Many things may be criminal yet completely legal, the rise of computer generated programme trading is simply a misuse of good technology. The abolition of open outcry has fundamentally changed the landscape of the trading game. Algorithms don’t feel love, fear, greed and ecstasy, but I do loath them. Of course, as Adam Smith noted, no system of price discovery is infallible, on the Liffe floor things were not perfect but the independent eyes of the law were trained on the action. Open outcry and human interaction trumps the current proposition every time.

Algorithms and high frequency trading (HFT) have corrupted our price discovery, or “truth” mechanism. Algorithms are inhuman in nature and high frequency trading is simply a corruption of technology. The latest Bloomberg article is a case in point. Just to highlight a few of the implications, an individual human trader can now no longer be the best bid or offer in a market as high frequency programmes jump ahead of genuine business simply due to the magic of zero’s and one’s, order routing techniques and proximity to exchange servers. Any argument which tries to claim this practice provides much needed liquidity is flatly countered by the facts. It simply increases short term, intra day volatility, widens aggregate bid/offer spreads and increases transaction costs for genuine business, such as industry hedgers. Major price moves are exacerbated as the programmed machines, which are based on ultimately similar mathematical models, form into predatory black shoals hunting for pray. Positive benefit is monopolised into a decreasing number of hands by this misuse of good technology.

Humans are beautiful and flawed, good and sometimes bad, but within all of us lies a desire for the truth. My trading style, love it or hate it, tries to look at all available evidence in black or white. Only then can I make a balanced assessment of the truth, in any situation. Once I have bought or sold my assessment, the market will tell me whether I was right or wrong, and if wrong, I change my position or don’t have one at all. When free, the market always tells the truth, the aggregation of individual assessments. Unfortunately, our major markets are not operating as they were designed to do, they are not free, open and transparent. This must change for us to progress otherwise we will never know the truth of a situation. To desire the truth makes us human, and as I was always told, “the truth is beauty and beauty is the truth”.

To declare a questioned prejudice, I haven’t enjoyed trading in un-free markets and I’m seriously considering swimming ashore, a better and wiser man, to take up writing about them instead.

In gambling with free markets we risk polluting capitalism, the best price discovery mechanism we have. The words “free” and “markets” go together like “truth” and “beauty” or “love” and joy”, perfectly matched. Financial markets and by extension capitalism once operated with honour and integrity, and unless we re-establish this principle we will merely be a Wild Wild West, of a self inflicted and failed model. Good thriving businesses require markets free and open for price discovery for us to remain human in nature.




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