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Monsters in the Market
Old 06-16-2010, 05:05 AM   #1
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Monsters in the Market

What chance does the individual Investor have against this?

Monsters in the Market - Magazine - The Atlantic

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Bred and trained in secret by Citi’s financial engineers, Dagger can stalk through more than 20 markets, public and otherwise—hunting for anomalies, buying and selling, prowling through mountains of historical data—all at the behest of Citi’s clients. Amid the trading-floor din, Dagger fulfills its duties in flickering silence, with a speed and acuity no human can match.
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By some estimates, algorithms now trigger 70 percent of all trades in U.S. equities. The speed and volume of everyday trading have propelled the market into a new and esoteric dimension, and rendered traders in the pits largely obsolete. Average daily share volume on the New York Stock Exchange increased by 181 percent between 2005 and 2009, while the time required to execute a trade on its electronic systems dropped to 650 microseconds.
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Old 06-16-2010, 10:30 AM   #2
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What chance does the individual Investor have against this?
Yeah, look at what the software has done to Citi's stock price.

"If these guys are so smart..."
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Old 06-16-2010, 10:49 AM   #3
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What chance does the individual Investor have against this?
Just another reinforcement of why my decision to focus on dividends is the way to go for me.
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Old 06-16-2010, 10:53 AM   #4
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This would seem to bolster the argument for those who believe in "efficient market theory." If something is priced way out whack, these programs can buy or short them and bring the price closer to fair value.

Having said that, it's scary what these things can do, as the recent 1,000 point decline in the Dow shows. And it does make the game feel a little more rigged, as if I were a high school baseball team trying to compete with the Yankees.
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Old 06-16-2010, 11:06 AM   #5
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The 1000 pt change in the Dow just means lots of opportunity. If you knew the Dow and stock market were going to fluctuate, you would take advantage of that would you not?

Wait a minute, you mean rebalance when the market goes up and rebalance when the market goes down? Didn't they show that doesn't work? No, they showed that rebalancing on January 1st every year doesn't work.
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Old 06-16-2010, 01:59 PM   #6
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What chance does the individual Investor have against this?

Monsters in the Market - Magazine - The Atlantic
I think that depends on what you mean by 'investor.'

These systems automate the day trader's search for 4 1/2 cent nickels. They look for inefficiencies in the markets, such as differing prices on different exchanges (arbitrage), or spreads between bid and ask that might be closed (high frequency trading). So, yes, a day trader 'investor' flipping stocks is up against some killer competition.

Investors who think in terms of months or years don't have nearly the concern. This stuff is just noise for mutual fund investors, and for ETF holders, just a reason to be careful about market NAV and an incentive to use limit orders.
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Old 06-16-2010, 03:54 PM   #7
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These systems automate the day trader's search for 4 1/2 cent nickels. They look for inefficiencies in the markets, such as differing prices on different exchanges (arbitrage), or spreads between bid and ask that might be closed (high frequency trading). So, yes, a day trader 'investor' flipping stocks is up against some killer competition.
Back before the latest split of the Berkshire Hathaway 'B' shares -- when they had 1/30 the economic rights of an A share -- I knew someone who did this several years ago.

For a long time, the usual ratio of price from A to B class shares ranged from 30.5 to a little over 32. (I once had a graph of this to confirm it.) If he started with one A share (for example), when the ratio of A to B price got to about 32, he'd sell an A and quickly purchase 32 B shares. When the ratio was below 31, he'd sell 31 B shares and buy an A share. Now he had his original A plus an extra B. There's a little friction to commission and bid/ask spreads -- not to mention the lack of A share liquidity -- but in the end, after one full round trip like this he wound up with close to one more 'B' share than he had before. On rare occasion the lack of 'A' share liquidity wiped out much of the arbitrage gain, but usually he came out ahead.

Over the course of a year, he said he used this arbitrage to add something like 16 B shares into his account. (At the current value of the 'old' B shares at around $3600, that's not a bad return for a relatively low risk arbitrage.)

These days the "spread" between A and B shares isn't nearly as great or as variable as it used to be, so I suspect programs are doing the arbitrage. Plus now there are 1,500 B shares in the economic rights of an A, not 30.
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Old 06-16-2010, 04:13 PM   #8
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What chance does the individual Investor have against this?

Monsters in the Market - Magazine - The Atlantic
I've tried to figure out the impact. To me, nanosecond traders increase the price I pay a little and decrease the price I sell at a little. (The missing money covers their expenses and profits.) Net, I lose x% on every round trip.

If I'm a a long term investor I don't make a lot of round trips, so the loss over my typical holding period is real but survivable (it won't cause me to not buy stocks). If I were a day trader, it would be a different story. These guys are probably better than almost all individuals at that game.

If I buy index funds that hold most positions for long periods, then I'm in the "not many round trips" category.

It's frustrating to see people siphon money from long term investors without providing an equivalent benefit, but it doesn't seem to kill stocks for ordinary investors.
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