Monday, August 20, 2007

Algorithmic Trading Systems - Trouble ahead?

UBS Bank continues to develop in the algorithmic trading market (and also continues the tradition of being rubbish at naming funds) with the launch of the UBS Commodities Portfolio Algorithmic Strategy System (Comm-PASS). The system is a portfolio based algorithmic strategy developed to benefit from momentum movement in long and short commodity positions on an auto trade basis.

The portfolio is based in five sectors; energy, base metals, precious metals, agriculture and livestock and is a basket of strategies from nineteen commodity futures markets.

'As familiarity with the commodities asset class grows, an increasing number of investors are recognising the value of taking a more active approach with their investment strategy,' says UBS's global head of commodities Peter Ghavami.

'UBS Comm-PASS is the first of a new generation of portfolio-based algorithmic strategy products for the commodities asset class which allows for the generation of returns in both bull and bear markets.'

The individual strategies generate long or short signals in the individual commodity, which takes into account both the trend and the counter trend of specific commodities in combination with the asymmetric return distribution seen in the commodity markets.

'For the last few years, commodity price volatility has been substantially greater than other asset classes, largely due to supply concerns as well as changes in global consumption and the influx of financial commodity investments,' says James Paget, co-head of structured commodity sales for Europe, the Middle East and Africa.

'High volatility offers trading opportunities provided an appropriate trading strategy is implemented. We believe Comm-PASS offers investors the opportunity to generate high returns by exploiting commodity market characteristics.'

With algorithmic trading systems reportedly getting a battering over the last few weeks ,this is a brave time to be selling such a system of trading to clients, but if anyone knows what they are doing, in our opinion, it is UBS.

I am sure we will start to see more and more use of algorithmic trading systems, however, is there a danger in this? Essentially algorithmic trading systems were developed to be able to execute large volumes of trades by splitting these trades up into smaller lots and programmed to create any mathematical outcome that the trader wants. The trading patterns can, of course be customised for example trading more at the close, when volume is higher, and less at lunchtime when its not. The thing is, are these trading patterns predictable?

Some critics say that when less experienced hedge- or mutual-fund traders use the software they've bought from Wall Street, they inadvertently expose their trades. How? Canny traders, mainly those who trade on behalf of big banks and brokerages with the firms' capital, may be able to identify patterns of algorithms as they get executed. "Algorithms can be very predictable," says Steve Brain, head of algorithmic trading at Instinet (INGP ), the New York City-based institutional broker.

Most Wall street firms will go to their deaths saying that there are no leaks in information about their trading strategies and argue that such leaks would kill their business because advantage would be lost and this argument makes sense.

With the algorithmic trading systems becoming more prevalent, will this affect the market itself? Take the human element out of trading and you have, in our opinion, lost some of the magic of the market, levelling out volatility and therefore opportunity. Ever played Chess against a computer? There is always the feeling that it knows what you are doing before you do it and it makes the competition element (and the fun) go out of the game.

And how long will it be before someone at MIT comes up with a computer trading system that analyses trades in a specific market and identifies the algorithms of the big trading houses and thus creates its own predictive trading systems? Paranoid, me? Who said that?

Of course there is a human cost to this also. If computer systems are more prevalent, why would you need a trading floor that you have to pay millions in bonuses to? Best to spend $5mn on a computer trading system that trades day and night, does not take holidays and does not want to go and work for another bank when you don't pay it enough.

The scariest thing for me, however, is the very thought of more and more systems coming into play and the market being worse for it. Sure, things would poottle along a with a little more stability, we probably wouldn't see the wild swings we do on the exchanges and we could all rest safe in the knowledge that our money is being managed by highly sophisticated computer systems rather than the banks twenty year old Ferrari driving, hung over maniac with a machismo complex. But would it be as much fun?

I don't know about you, but when I decided to get into this business, when I was a boy, it was the very fact that what we do is exciting, stimulating and a test of man against the market. Playing the computer at Poker is fun when you are practising, but its just playing the odds programmed into it. I am sure we all prefer it when we scoop up a few hundred dollars having just convinced other players that our pair of two's was a Royal Flush.

Algorithmic trading is great, we love it, but we just hope that its not the beginning of the end of the traditional trading floor being replaced by teenage 'Googlers' sitting on bean bags and playing Foosball while creating ever more clever computer trading programmes which just make the market....well... predictable and boring....

1 comment:

Anonymous said...

lets just keep our fingers crossed