Algorithms Take Control of Wall Street

Is this a modern day adaptation of Frankenstein’s monster… ? Computer algorithms are controlling the financial markets. Their "brains" are bigger, faster and more powerful than any human mind trying to trade along side. And they’re playing with more money. They don’t mean to, but they do, cause flash crashes and market distortions that their human creators cannot predict or prevent, let alone comprehend. – Ilene

Algorithms Take Control of Wall Street

By Felix Salmon and Jon Stokes, Wired Magazine

Last spring, Dow Jones launched a new service called Lexicon, which sends real-time financial news to professional investors. This in itself is not surprising. The company behind The Wall Street Journal and Dow Jones Newswires made its name by publishing the kind of news that moves the stock market. But many of the professional investors subscribing to Lexicon aren’t human—they’re algorithms, the lines of code that govern an increasing amount of global trading activity—and they don’t read news the way humans do. They don’t need their information delivered in the form of a story or even in sentences. They just want data—the hard, actionable information that those words represent.

Lexicon packages the news in a way that its robo-clients can understand. It scans every Dow Jones story in real time, looking for textual clues that might indicate how investors should feel about a stock. It then sends that information in machine-readable form to its algorithmic subscribers, which can parse it further, using the resulting data to inform their own investing decisions. Lexicon has helped automate the process of reading the news, drawing insight from it, and using that information to buy or sell a stock. The machines aren’t there just to crunch numbers anymore; they’re now making the decisions.

That increasingly describes the entire financial system. Over the past decade, algorithmic trading has overtaken the industry. From the single desk of a startup hedge fund to the gilded halls of Goldman Sachs, computer code is now responsible for most of the activity on Wall Street. (By some estimates, computer-aided high-frequency trading now accounts for about 70 percent of total trade volume.) Increasingly, the market’s ups and downs are determined not by traders competing to see who has the best information or sharpest business mind but by algorithms feverishly scanning for faint signals of potential profit.

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These sudden drops are now routine, and it’s often impossible to determine what caused them. But most observers pin the blame on the legions of powerful, superfast trading algorithms—simple instructions that interact to create a market that is incomprehensible to the human mind and impossible to predict.

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But [measures to avoid flash crashes after May 6, 2010] are not ways of controlling the algorithms—they are ways of slowing them down or stopping them for a few minutes. That’s a tacit admission that the system has outgrown the humans that created it…. “Our financial markets have become a largely automated adaptive dynamical system, with feedback,” says Michael Kearns, a computer science professor at the University of Pennsylvania who has built algorithms for various Wall Street firms. “There’s no science I’m aware of that’s up to the task of understanding its potential implications.”