Algos Gone Wild – Stupid Computers Are GOOD for Smart People

Sal Arnuk of Themis Trading has been a vocal opponent of computer algorithm based high frequency trading since before the topic became mainstream.  Today, Sal has a great story of crazy algo pricing outside of the stock market (emphasis his):

“Sadly, algobots don’t only price Citigroup, and they don’t only price stocks in the CBSX High Freak High Rebate Enticement HFT We Love You program: AMZN Lists Book at $23,700,000…plus shipping.

It seems a Mr. Eisen, an evolutionary biologist who works at UCal Berkeley, noticed that two algobots are responsible for pricing a book he was interested in, The Making of a Fly. One algobot priced its book at 127% of the second algobot, and the second algobot kept pricing its book at 99.83% of the first algobot, in order to undercut it in price (and provide liquidity and create a tighter book spread for you LOL). The two bots chased each other such that the price of the book rose on AMAZON to $23,698,655.93 plus $3.99 shipping. I guess the $3.99 shipping charge would be analogous to the SEC fee we pay in the stock market?

Oh, and it is not a one-time event; the bots have reset, and even this morning the paperback is on the rise again, apparently with some type of price breaker or “volatility guard”, as the price has risen to only $976.98 for the paperback version. Again plus $3.99 for the SE…errr shipping.

So, now we have Flash Crashes and Flash Dashes outside the stock market!  Is everything being priced in the universe today, not with forethought, but rather as some relation to another price, which in turn is set in relation to yet another price? All without human intervention?  Is this wise? Is anyone doing the thinking? Is anyone doing “the work” in our stock markets, as well as on AMAZON? On the eve of the May 6th Flash Crash, perhaps it is wise to think about that question.”

Now, I keep trying to get this point across:  when “stupid” computers do “irrational” things in the market, that’s good for us sentient, cogent, “smart” carbon based life forms.  We make money trading in the market off of the stupidity of others (except, of course, for the problem that the Powers That Be don’t let the erroneous trades stand – that’s another issue).  Crazy algos doing crazy things in the market results in opportunities for you to make money.  Full stop. Think about it.

I find Sal’s book pricing algo story interesting – I would have expected the two algos to undercut each other’s price – ie, algo1 prices the book at 99% of algo2’s price, and algo2 retorts by doing the same thing.  The result?  Cheap books – smart people win again, picking off the stupid, irrational computers.  In this case, however, one algo was essentially coded to “not provide liquidity” – so no one bought the book.  I’m guessing that consumers as a whole have saved craploads of money over time, though, as a result of competitive algo pricing on products that they buy.

There’s an online poker analogy too.  Some players complain about the preponderance of poker ‘bots – computerized programs that play by a fixed set of rules.  Of course, any serious poker player knows that if you know how your opponent plays, it’s a matter of time before you can gain an edge on them, exploiting their tendencies.  Thus, I’d welcome the opportunity to play against a non-adaptive “stupid” poker bot* that doesn’t play like a smart, thinking, human does, just like I welcome the opportunity to trade against a bunch of algos who are mis-programmed to feed-back into each other and create mis-pricings that I can exploit (alas, I think that most of the algos out there are “smart” enough that they aren’t easy to “beat” on a regular basis).  If only we’d have widespread Flash Crash’s more often – it would make it so much easier to make money!  What’s the first thing I did after the Flash Crash – I put in good-until-cancel discount bids in a handful of stocks and ETFs, HOPING for a repeat.    Back to Sal’s post, from before he told the book pricing story, in fact:

“Over two years ago we wrote a mini white paper, and article for Advanced Trading, titled “What Ails Us About High Frequency Trading.” In that paper, one of our points was that we were concerned about high frequency trading (HFT) causing a disconnect between market prices and real asset values. If 60-70% of the market activity is computerized algobots bouncing off each other, then is there a positive feedback loop type thing going on? High frequency proprietary trading and market-making takes some security price as a reference point, and shoots off of it with rapid speed, always keeping the algobot competitive. While this system lets you buy and sell Citigroup with just a penny spread, what about the fact that their reference points are all in turn reference points created by them?”

Again, if algos or anything/anyone else is causing a disconnect between market prices and real asset values, that’s an opportunity for everyone else – an inefficiency created for us to exploit.

related:  KD’s Flash Crash recap post – with links to 5 previous Flash Crash posts


*I say non-adaptive because the vast majority of such ‘bots are simplistic and rules based.  There are, of course, groups like the University of Alberta who have been developing more advanced artificial intelligence ‘bots that attempt to adapt to your play – but such development is extremely difficult and expensive, and an ongoing process

postscript – Show me an article about the algo in charge of security at a nuclear reactor going rogue, or the algo that controls water levels at a dam flooding a town,  and I’ll be on board with it as something that’s NOT good for us sentient beings.  Algos making stupid trades, on the other hand, offer opportunity for everyone else.

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