By Hal M. Bundrick
NEW YORK (MainStreet) -- It's an invisible stock market lorded over by a new machine ecology executing trades at a speed undetectable by human beings. Researchers say this subsecond market activity shows "an intriguing correlation with the onset of the system-wide financial collapse in 2008" and generates a hidden universe of competitive machines so advanced "humans lose the ability to intervene in real time."
And this nano-market mastered by aggressive, high frequency trading bots crashed over 18,000 times from 2006 to 2011.
Led by Neil Johnson, a University of Miami physics professor, a group of researchers analyzed millisecond-scale stock market data from Nanex and identified large numbers of subsecond "ultrafast extreme events" (UEEs).
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"Our findings are consistent with an emerging ecology of competitive machines featuring 'crowds' of predatory algorithms, and highlight the need for a new scientific theory of subsecond financial phenomena," the study says. Johnson and his fellow researchers say there is a billion-dollar "technological arms race" underway to reduce communication and computational operating times down to several orders of magnitude below human response times -- toward the physical limits of the speed of light. "For example, a new dedicated transatlantic cable is being built just to shave five milliseconds off transatlantic communication times between U.S. and U.K. traders, while a new purpose-built chip iX-eCute is being launched which prepares trades in 740 nanoseconds," the report states. "In stark contrast, for many areas of human activity, the quickest that someone can notice potential danger and physically react, is approximately one second. Even a chess grandmaster requires approximately 650 ms just to realize that she is in trouble (i.e. her king is in checkmate)."
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The team uncovered an explosion of UEEs beginning in 2006, just after new legislation came into force that made high frequency trading more attractive. "We find 18,520 crashes and spikes with durations less than 1500 ms in our dataset," the researchers say. These flash trades adjust back to the prevailing market price within milliseconds. Science officer Spock would certainly say that this was all quite "fascinating," but would quite likely add, "A difference that makes no difference is no difference."
Indeed. If these hyper trades revert to the mean at a speed imperceptible by humans, what's the problem?
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"As long as you have the normal combination of prey and predators, everything is in balance, but if you introduce predators that are too fast, they create extreme events," Johnson says. "What we see with the new ultrafast computer algorithms is predatory trading. In this case, the predator acts before the prey even knows it's there."
The invisible bot mobs could be responsible for increased market volatility and systemic failures like the recent "flash freeze" that shut down the Nasdaq.
"Our findings show that, in this new world of ultrafast robot algorithms, the behavior of the market undergoes a fundamental and abrupt transition to another world where conventional market theories no longer apply," Johnson says. --Written by Hal M. Bundrick for MainStreet
