Kevin Slavin is the co-founder of the computer game developer Area/Code. He lives in the world of algorithms, which he describes in a 2011 TED lecture as “basically the math computers use to decide stuff.”
Computers, being fairly dumb brutes, need instructions from humans who write the algorithms in complex code. Slavin notes that in today’s world algorithms control most of how people interact with video games, Internet searches, social networking, and thousands of other functions.
Algorithms Control Market Trading
One of the major applications for algorithms is in the financial industry.
That’s why, Slavin says, Wall Street now employs 2,000 physicists and math wizards whose work involves writing algorithms to instruct computers in the trading of bonds, stocks, currencies, and other financial instruments.
These formulas now control 70 percent of the trading in U.S. financial markets. The algorithms enable computers to analyze billions of bits of information about trading around the world almost instantaneously and to spot trends. This, as described by CBS News correspondent Steve Kroft on 60 Minutes (October 2010), instructs “robot computers capable of buying and selling thousands of different securities in the time it takes you to blink an eye.”
Kroft reports that these “electronic exchanges” are owned by the big financial companies, which wouldn’t let the news organization see them or film them: “but they trade more than a billion shares a day at blinding speed, and most of those bets are being made by machines.” (Note the use of the word “bets”).
Speed is the Key to Beating Trading Competitors
Steve Kroft mentions blinding speed – but how blinding? Mathematician Manoj Narang is with a company called Tradeworx. He told Kroft that, “Humans are not involved in the trading because humans are way too slow to trade on the kinds of opportunities that we’re trying to capture. We’re trying to capture opportunities that exist for only fractions of a second.”
A market trader using a mouse to execute a buy or sell order is way too slow to get an edge on the competition in the world of electronic trading. It takes about 500,000 microseconds to click a mouse. Kevin Slavin comments that “if you’re a Wall Street algorithm and you’re five microseconds behind, you’re a loser.”
So, financial houses have located their servers as close to the Internet feed as possible where they capture information a few vital microseconds earlier than competitors a dozen or more blocks away.
The Flash Crash of 2:45
Back at TED, Kevin Slavin asks “What could go wrong?” He then answers his own question by referring to the “Flash Crash of 2:45.”
On May 6, 2010, the value of shares on the New York Stock Exchange suddenly plunged at 2:45 in the afternoon. As Jane Wakefield of BBC News reports the flash crash caused the Dow Jones Index to plunge 10 percent in five minutes: “A rogue trader was blamed …but in reality, it was the computer program that the unnamed trader was using that was really to blame.
“The algorithm sold 75,000 stocks with a value of £2.6bn in just 20 minutes, causing other super-fast trading algorithms to follow suit.”
Wakefield notes that, “No one has ever managed to pinpoint exactly what happened, and the market recovered minutes later.” However, regulators have installed circuit breakers to detect rapid stock price drops and halt trading until technicians can figure out what’s going on.
As Steve Kroft commented in his 60 Minutes broadcast, “The crash contributed to the crisis in confidence on Wall Street. Since last spring, people have pulled $70 billion out of mutual funds and the biggest concern…is that average investors have lost faith in the integrity of the system.”
Sources
- “Kevin Slavin: How Algorithms Shape our World.” Kevin Slavin, TED, July 2011.
- “How Speed Traders Are Changing Wall Street.” CBS News, October 11, 2010.
- “When Algorithms Control the World.” Jane Wakefield, BBC News, August 22, 2011.
Rupert Taylor - Rupert Taylor is the editor of a magazine that provides background to current events.
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