Paul Wilmott's Blog

Fitch Acquires 7city - great news for the CQF!

Thu, 24 Jan 2013 09:30:00 --0100

Fitch and 7city are forming "Fitch 7city Learning," press release below. This is fantastic news for the CQF as it means an already brilliant course is now unstoppable in its goal to improve quant finance and risk education globally! P PRESS RELEASE: Jan 24 - Fitch Group today announced it has acquired 7city Learning, a leading provider of learning and development solutions for the financial services industry. Fitch is combining 7city with its Fitch Training unit to form Fitch 7city Learning, a global leader in financial training. Paul Shaw, previously CEO of 7city, will lead Fitch 7city Learning. The financial terms of the transaction have not been disclosed. Fitch 7city Learning will benefit from 7city's industry-leading solutions for delivering financial services training combined with Fitch's global presence and platform. Fitch 7city will specialise in global development and delivery of training in four key areas: regulatory and certification exam training (i.e. Chartered Financial Analyst, Certificate in Quantitative Finance); professional skills training; custom e-learning solutions for client organisations; and credit, risk and corporate finance training, which is currently provided through Fitch Training. "7city is an innovator in promoting understanding of financial concepts and practices - something we view as core to Fitch's role in global markets," said Paul Taylor, President and CEO of Fitch Group. "Fitch has long believed that transparency contributes to efficient markets, but the real market value of transparency is not how much is shared but rather how much is understood. Paul Shaw and the 7city team have successfully paired a strong intellectual and practical foundation in learning with a superior sense of global customer service. We are delighted to have them as part of Fitch Group." "Fitch Group is an outstanding fit for 7city. Both companies are growth oriented, globally focused and committed to broadening knowledge and perspectives," Mr. Shaw commented. "Fitch 7city has an opportunity to impact global markets in a profoundly positive way through promoting greater understanding among individuals and leading financial institutions." Formed in 2000 with a vision to build both time and cost-efficient solutions to support its clients' learning and development needs, 7city is recognised by financial professionals and analysts around the world for the quality of its innovative training methods. Based in London with offices in New York, Singapore and Dubai, the company has more than 150 employees serving a broad spectrum of top-tier financial institutions, companies and organisations. 7city previously was majority-owned by Gresham Private Equity. Fitch Group is a global leader in financial information services with operations in 36 countries. In addition to Fitch 7city Learning, the Group includes: Fitch Ratings, a global leader in credit ratings and research; and Fitch Solutions, a leading provider of credit market data, analytical tools and risk services. Fitch Group is 50% owned by Paris-based Fimalac and 50% owned by New York-based Hearst Corporation.

Have You Had An Illness That Wasn't Your Fault?

Wed, 14 Nov 2012 07:54:00 --0100

Scientific advance that is certainly to be exploited by ambulance-chasing lawyers: DNA sequencing of MRSA used to stop outbreak. This is the beginning of the story that I've been predicting for years. Thanks to the genetic mutation of diseases you can now trace the source of an illness back to the source, i.e. that dastardly person who didn't disinfect their hand before, during and after using a door handle. Hot stock tips: Anything medical; Lawyers; Insurance companies; Producers of disinfectants; etc. I hate lawyers. P

High Frequency Trading and the UK Government?s Whitewash

Fri, 26 Oct 2012 10:24:00 --0100

The UK Government?s Foresight Project has just announced the results of its two-year investigation into electronic trading and markets. And the good news for hedgies is that they?ve decided that high-frequency trading is mostly safe! Let the party continue! And the bad news? None really. That?s unless you believe government reports should be unbiased, independent, forward thinking, etc. etc. One group of journalists from The Bureau of Investigative Journalism has observed that the Foresight panel, the ?High Level Stakeholder Group? made up of senior individuals from relevant institutions, is not exactly unbiased. Their nice analysis is here. The story I was told by one of the Bureau?s journalists was that anyone who was anti HFT was discreetly dropped from the investigation. For example?er, me! In the early days of the project, two years ago, I was asked to contribute?and then after hearing my views the Foresight team went strangely quiet on me. And it wasn?t just me, it turns out that lots of other people were also found to be surplus to requirements. The list of members of the Stakeholder panel is here. It?s not even subtle is it? The majority of those on the panel directly benefit from HFT. The report takes the tired, old, shallow viewpoint about HFT adding liquidity, without delving any deeper. Yes, there?s lots of statistics in there. But excuse me for thinking that a panel with the name of ?Foresight? ought really to make some effort to look beyond the past into possible future scenarios. It may not be easy to estimate the probability of various scenarios but it?s not hard to figure out their effects. The project made little attempt in that direction. I?m disappointed in many ways: Partly because I was dropped and so missed an opportunity to serve Queen and country; Partly because the result was not independent, resulting in precisely the outcome that the government wanted; Partly because few have picked up this rather important story. But mostly I?m disappointed because the rigging of the panel was so blatant, so arrogant in its execution, and so narcissistic the belief that they?d get away with it. This Foresight report is already being quoted as the most important and most detailed analysis of computer trading ever. It is bound to have a major influence on the future of the financial markets. And it?s a complete whitewash. P

My Experience Of The OCC And Their Understanding Of Risk

Mon, 11 Jun 2012 10:50:00 --0100

I can now reveal that is was the OCC... The nameless regulator I criticized in my blog on calibration, "Bankers Can't Avoid Risk by Hiding It," was the Office of the Comptroller of Currency in Washington. The OCC has had a lot of negative publicity recently for their less-than-rigorous examination of JPMorgan in the run up to that bank's multi-billion dollar losses. Just to recap what I said before, the OCC were unintentionally encouraging banks to hide model risk by requiring calibration when the role of the regulator should be to point out the downside of calibration and instead ask about the stability of the calibrated parameters. Certainly the concept of model risk, and the difference between hiding risk and hedging it, seemed beyond them. So it didn't come as a surprise to me that the difference between hedging and speculation also proved too much for their very theoretical brains. To add a bit of balance here, my experience of the OCC was not dissimilar to my experiences of many quant teams in banks. By this I mean that they love to talk mathematics but struggle to talk markets. When you've had a quant education that's too academic then all you've seen is complete markets and risk neutrality, so it's almost understandable that you don't appreciate model risk. It doesn't exist in complete markets! And of course in the risk-neutral world you pretend as if everything earns the same rate of return and risk has no value! It's all beginning to make sense! Part of the solution is more robust education and better critical thinking. But the cynic in me thinks that if regulators were better educated in the 'practice' of banking then there'd be less trading, smaller bonuses and fewer donations to political parties. P

New Flag For Old

Fri, 24 Feb 2012 13:20:00 --0100

Replace the Scottish Blue with the Welsh Green? It has a certain 'freshness' about it. I don't think it works as well on a tie, but the new flag is actually much better than the old on a waistcoat, for those gentlemen with sufficient chutzpah. What do you think? P

Europe - What's the point?

Mon, 12 Dec 2011 14:03:00 --0100

I have always believed that the EU and the Euro are simply ego trips for a few Northern European politicians, their desire for a legacy. For Southern and Eastern Europeans the EU and Euro are a quick route, during the good times, to riches. There is absolutely no reason for a club of such different peoples to succeed. Most arguments in the EU?s favour are complete nonsense. For example: 1. Trade: You don?t need a club for efficient trade. This is clearly seen throughout the world by the size and growth of trade with China and India. What you need is efficiency in production and transport, you need control over wages and taxes. 2. Mobility of skills: Each country needs to create its own skilled people otherwise there is far too great an exposure to a critical component of a country?s wellbeing. Most of the arguments in favour of the EU are examples of extremely shallow thinking. The desire for 23 (at least) of the EU?s constituent countries to increase their links when it is clear that they are falling apart is a typical knee-jerk bridge burning. But bridge burning is only good if it increases the probability of success. This is not the case here. It increases the damage when the inevitable happens. (I look forward to the day when a TV news item on the tightening of European links is followed immediately by an item on Scotland seeking devolution from the UK. I rather expect that comparisons will not be drawn.) David Cameron has exercised the UK veto on the vote for closer fiscal ties. These ties would have imposed constraints on constituent countries? budgets with punishments for violation. So punishment for something that is often going to be impossible without the flexibility of multiple currencies. Come back, King Canute, maybe you can advise here! Meanwhile Nick Clegg wants the UK to be at the ?heart of Europe? so that we can have an impact on international events, our relationship with the US being somewhat on the wane. One can rarely go wrong by asking any politician, ?So what?? In this case if we want to have an international impact then we need to prove that we deserve this, not by hanging onto others? coat-tails, whether they are American or European. If you want to have international clubs then they need to have certain properties, for example: 1. Complementarity: There is no point in countries banding together unless they can each offer the other something. (Unless a country is so tiny as to benefit from economies of scale.) 2. Values: There must be a commonality of values, otherwise any union will bring animosity. I don?t think that the taxpayers of Northern Europe are exactly keen on bailing out the tax-avoiders of Southern Europe. All of this leads to the inevitable conclusion that the UK is better off out of the EU, and much better off by building up the influence of the Commonwealth.* P *Not only do they speak English and play cricket, but they mostly drive on the left-hand side of the road and use the same electric plug!

Taxation To Slow Down High-Frequency Speculation While Not Affecting Hedging Activity

Fri, 11 Nov 2011 12:29:00 --0100

The Tobin (or Robin Hood) Tax was proposed decades ago by the eponymous Nobel Laureate (that?s James Tobin, not Robin Hood) as a means of stabilizing currencies via a small tax on all transactions. Every few decades the idea comes back, although no longer confined just to foreign exchange. There are various reasons why it keeps being dismissed, reasons such as infeasibility, elimination of incentives, requirement for the initiative to be global, etc. One assumes, though, that it?s the political clout of the bankers that is the real reason why this has not been adopted. My sense is that the time might now be right for the adoption of the Tobin Tax, thanks to the valid fear over high-frequency trading and thanks to the widely held low opinion of bankers. Countries are going to have to learn to cooperate thanks to the recent financial crises, and what better place than a tiny little tax? And the technology is in place. But there?s the question of how tiny is tiny. Tobin himself said ?let?s say 0.5%.? It wasn?t meant as a well-thought-out number, and it?s certainly far too high given typical bid-ask spreads. So what is a better number? Trading happens for a number of reasons. Let?s focus on just two, hedging and speculation. Hedging is generally considered to be a good thing, as it is meant to reduce risk. Speculation can be good or bad. In my opinion it?s bad when it happens at such a high frequency that the relationship between the share price of a company and its value becomes irrelevant to making money. So let?s say we want a tax that?s big enough to hamper the shortest-term speculation, while small enough not to affect hedging. The mathematics of hedging of derivatives in the presence of transaction costs goes back to Hayne Leland (1985) for simple calls and puts. Later this was extended to incorporate any derivatives by Hoggard, Whalley and yours truly. Out of this work comes a simple non-dimensional parameter related to costs, volatility and hedging frequency that tells you how much your hedging will affect you P&L. It?s all in PWIQF2 if you want the details. Supposing that you wanted to have less than 1% effect on profitability of a derivative (and that number is open to discussion but is easily well within the margins of model error), and supposing you hedge every day in a market with 20% volatility (again, two numbers that you are free to dispute or change), then the tax could be at most 0.008% of the value of each trade. Around one basis point. Would this level affect good hedging? No. Would it affect speculation over medium and long term? No. Would it dampen short-term speculation? You bet. P

Bankers Can?t Avoid Risk by Hiding It

Wed, 09 Nov 2011 14:22:00 --0100

(A version of this was first published on Bloomberg.com on May 24, 2011.) One of the supposed silver linings of our recent economic disaster was the idea that we finally understood how hazardous our exotic financial instruments are and that bankers were finding a better way to "manage" that risk. But if at least one of the common practices in banking is anything to go by, risk-management procedures in many cases continue to hide the very dangers they are trying to measure. This may result in banks taking bigger positions, and end up taking more real risk than they should. And it gets worse. The practice in question goes by the name of "calibration," which is best described using a non-financial example. Springs are the basis for simple weighing machines. Attach a weight to the end of a spring and it will stretch. Measure how much the spring stretches. Repeat using a different weight. You will find that the extension is proportional to the weight. (Up to a certain point. If the weight is too great this relationship breaks down, and the spring may not even return to its rest state.) This relationship is named Hooke?s Law after the English scientist who described it in the 17th century, Robert Hooke. F=kx, where F is the force or weight, x is the extension of the spring and k is some constant. To use this in practice, just attach a known weight to the spring and measure its extension. You know F, you know x, you can then infer the k. This is calibration. Once you know k, you can weigh anything else, take the extension and multiply by k and hey presto! Now let?s see how this idea is applied in finance. Your goal is to value some complex financial structured product. You have a valuation model with lots of lovely mathematics. But the model requires the input of parameters. You may need volatility, probability of default and other numbers, depending on the model and the instrument. A collateralized-debt obligation, for example, would require the input of lots of default parameters. Yet those parameters are for future volatility, future default risk and so on. How can we possibly know what these parameters are? Typically, people seek guidance from simpler products, such as options and credit-default swaps, that are widely traded in the market. These simpler products also depend on the same unknown parameters, but their value is known since they are traded. With these simpler products, you work backwards, from value in the market, to find the unknown parameters -- in much the same way as you find the k for the spring. Once the parameters have been found, you can then use them in valuing other, non-traded, so-called exotic financial instruments. So where?s the harm? The beauty of Hooke?s model is that whatever weights are used to calibrate the spring, you get the same k. The stability of the parameter is a sign of a good model. This doesn?t happen in finance. You calibrate your derivatives one day, and then come back a week later to find your parameters have changed. This indicates the model is wrong. If finance were a proper science, then this simple and blatant failure of the model would result in it being tossed out and require a trip back to the drawing board. In the context of the CDO, we might get information about the probability of default of the individual companies making up the instrument by looking at the credit-default swaps for those companies. But how much real information can there be in those CDS prices, especially since the company in question hasn?t yet, by definition, gone bankrupt and therefore the statistical sample size is zero? You can see where I?m heading with this. Finance doesn?t meet the basic requirement of science: repeatable results. The models aren?t capable of any great level of precision. In finance, when models are calibrated, they always have to be recalibrated a week later. But those parameters are supposed to remain fixed for evermore. If they have to be changed, then the model either was wrong before, is wrong now, or more likely both. I?m not saying that we?ll ever find a perfect finance model, but we should be aware of the limitations -- that is to say the model error -- of whatever model we do use. And by calibrating we throw out all objective measure of model risk. Risk has been very effectively hidden. An objective test of the accuracy of a model is how well the theoretical value matches market prices for traded instruments. And in a calibrated model it does that perfectly, but it only appears correct at that one instant in time. And that appearance is very deceptive. Next week, or even tomorrow, or just an hour later, theory and practice will inevitably diverge. But if you are forever recalibrating, you never see this. Yet the very act of recalibration negates the model value that you thought was correct. Hence my comment that appearances can be deceptive. The value wasn't even correct at that one original instant. Recalibration means that risk managers remain in blissful ignorance of the errors in their model and hence the risk. If anything ever gave a false sense of security, this is it. All that risk management has done is to hide the risk, making it harder to spot, to estimate and to hedge. I visited a regulator (who shall remain nameless) in Washington recently. People say that regulators don?t have enough bite, so I went there to offer a set of teeth. My goal was to arm them with one simple, surefire way to frighten the pants off any bank. My advice was to ask the banks one simple question: "So, how stable are your calibrated parameters?" The bankers would then find some respect for the regulators. Instead, I found myself surrounded by quants praising calibration, not even appreciating the negating effect of recalibration. It doesn?t take a rocket scientist to figure out the fallacy in calibration, but it does take someone who can look beyond the math.

Occupy Wall Street? I Never Heard Such A Thing!

Sun, 02 Oct 2011 11:37:00 --0100

I've been popping downtown to Zucotti Park, near Wall Sreet, over the last few days. Did you know there's a protest going on, against bankers, corporate greed, corrupt politicians? You'd never guess if you got all your news from the US media. On CNN this morning they devoted almost eight seconds to the story of 700 protesters being arrested. Top news story was a man who'd fallen down an embankment. Second story was "American man found living in Portugal." The horror, the horror. The protesters seem mostly harmless. There's a very 1960's feel about them, including a topless young lady. "She doesn't have implants," a friend observed. Clearly she's spent too much of her life demonstrating bra-less. (The demonstrator, not my friend, I hasten to add!) The protesters have a system of public speaking whereby a person says a few words and the crowd repeats them so others can hear. This is forced on them by the banning of loudspeakers. Approval of a speaker is expressed by making wiggly rain signs with your hands. I followed one General Assembly meeting. After an hour they'd democratically agreed to set up two more committees. All very "Life of Brian." After that I went off to give a lecture on derivatives to some bankers. When in the States I sometimes like to watch Fox News. It reminds me how lucky I am to live in a country where the broadcast media isn't incentivized to manipulate the news. I also like to watch old men in make-up ranting about homosexuals. P

Quant Lessons From The Royal Wedding

Fri, 29 Apr 2011 22:38:00 --0100

I like to teach certain quant finance ideas by reference to real life, often involving supermarkets and tins of baked beans (see for example The Role of Mathematics in Finance: Relevance, Reliance, Robustness). This is a great way to dispel embedded foolish ideas and to open minds. I have this knack of connecting otherwise disjointed topics. Genius? Stupidity? Such a fine line. So naturally I?d like to point out a couple of aspects of the royal wedding that have quant implications! Theory vs Practice Something as blatantly unmeritocratic as the royals cannot possibly work according to any political theory. Obviously they are trivial to criticize, and to find fault with, but on balance the royals in practice are almost certainly a positive force for the UK. Then there are political theories. One from the mid 19th century springs to mind. Looking good on paper (even had a catchy manifesto!), the implementation didn?t quite pan out. Ok, a few million people died, but, hey, nothing?s perfect. Precisely. Nothing is perfect. And that applies to quant finance models. If perfection is not possible, just stick with what works. Aim for better not best. President Blair, President Brown? Less dogmatism in the theorizing, please. Pretty mathematics might be appealing in physics, the mind of god and all that, but not in finance. (Although I do know of a nice Manifesto.) Fear of Arbitrage A lot of people are bothered by the cost of the royal family. They cost a pound per UK taxpayer per year. It's costing you a pound! A pound! Look down the back of the sofa, you could fund your contribution for the next five years. The fact is that the existence of the royals is not materially hurting you personally. This reminds me of people who worry about the existence of arbitrage. They have it in their heads that it is somehow wrong. They worry to such an extent that they change and destroy otherwise reasonable quant models by forcing them to calibrate to every traded instrument. I call this the Fear of Arbitrage. But the strange thing is that they might not be trading some of these instruments. If you aren't trading them why do you care whether or not they are correctly priced? It?s not rational. It?s emotional. If people want to misprice things, let them. It might not be any of your business. Sorry to be so deeply uncool but I believe that variety is the spice of life! Congratulations, Catherine and William! P

HIQLEQ

Mon, 11 Apr 2011 16:57:00 --0100

In 1983 Howard Gardner proposed a theory of 'multiple intelligences,' and to date has listed eight different types: Spatial; Linguistic; Logical-mathematical; Bodily-kinesthetic; Musical; Interpersonal; Intrapersonal; Naturalistic. The interesting point about this is not the concept, which is itself reasonably obvious. The interesting point is the list itself, those specific eight areas of intelligence. A simplified version of this theory breaks intelligence down into just the two categories, the classical IQ and a measure of 'Emotional Intelligence' or EQ. In many walks of life, especially those associated with highly technical skills such as physics, programming, mathematics, law, and increasingly certain aspects of banking such as risk management and derivatives, it is common to find people who have very high IQs but low EQs: High IQ, Low EQ, or hiqleq (pronounced hick-leck). The jobs in modern investment banking have become very technical, requiring advanced mathematical and programming skills, and at the same time these bankers are having less interaction with customers, people from a wide variety of backgrounds with diverse personalities. Banks have become a safe haven, if perhaps not a breeding ground, for hiqleqs. I enjoy conversations with people who can bring together many disparate subjects and weave them to make an illuminating, entertaining, and fun, wide-ranging and free-flowing discussion, typically those people with both high IQ and high EQ. However, hiqleqs seem to feel uncomfortable when any discussion begins to stray in an unexpected direction or if conversational parameters are not defined to their satisfaction. In discussing research I similarly find that some people 'get it' and can improvise with an idea, being very creative, while others do the exact opposite and seem to stifle any originality. I don't mean they do it at all deliberately or maliciously, but just because they want rules or structure when there doesn't have to be any. Or to be more precise, discussion and exploration of ideas should be fluid and do not have to be as constrained as if they were a branch of rigorous mathematics. When speaking about risk or valuation ideas to mathematicians in investment banks, I often feel as if I am trying to explain the beauty of a red rose or the colours of the rainbow to someone who only sees in black and white. P

Rewarding Mathematics

Mon, 14 Mar 2011 10:16:00 --0100

We hear a lot about how talent will leave the major financial centres if taxes or regulations become unacceptable. That people move to more favourable locations is more or less plausible. But what seems to not ever be asked is how much talent does this "talent" really have? Combine this with what I have often said, that the mathematics of quant finance is straightforward if approached properly, and the following idea immediately suggests itself: Measure the ratio of typical salary in a quantitative field to the difficulty of the mathematics in that field. How much better off is the quant compared to the aeronautical engineer? And does salary correlate with talent? Quantifying the math difficulty, for the denominator in the ratio, is the hard part. Inspired by the kind of differential equations seen in many physical sciences as well as in finance we could start as follows. Parabolic equations 5 points; elliptic 10; hyperbolic or mixed 15. Four or fewer dimensions 5 points; five or more 10 points. Linear no points; nonlinear 10 points. The aero engineer might have a ratio of 5 (after rescaling by 1,000 to make the numbers neater), the quant a whopping 30. In other words the aero engineer ought to be on the quant's salary and vice versa. P

The "Inbox Test for Stability of the Global Financial Market"

Fri, 03 Dec 2010 12:34:00 --0100

Another day, another email in my inbox announcing another High Frequency Trading conference. I have nothing against the emails (we send quite a few of them ourselves) and I have nothing against HFT per se. But a large number of emails on the same subject in a short space of time is a sure sign of a bandwagon. And bandwagons are often bad news for the markets. More specifically bad news for shareholders, but often the cause for bumper bonuses for bankers. The last time my inbox was bombarded with emails of such monotony was during the heyday of credit derivatives. At the time I said that the credit derivatives models were stupid but unfortunately I hadn't fully realized the size of the market, and therefore the potential for systemic risk. The state of my inbox should have warned me. Now I know better. So according to my inbox there is far too much algo/hf/computerized trading. The minimal benefits this confers in terms of supposed "efficiencies" is far outweighed by the potential it has for causing chaos. Penny wise, pound foolish. P

Cyberterrorism

Tue, 19 Oct 2010 08:56:00 --0100

Cyberterrorism is in the news so I thought I'd share this little story with you. A year or two ago I was at a dinner of the Great and the Good. I sat next to an Ambassador. We chatted broadly about the threats facing the world: Terrorism (I said it could be much worse if terrorists had any imagination); Finance (there will be another crisis unless governments bite the bullet and simplify); Viruses/pandemics (a big one eventually but not for a while); etc. My general theme being the Global Village, everything being linked, no more survival of the fittest since there is in effect only one organism, etc. I dismissed global warming on the grounds that there are many threats with much shorter timescales. I also threw in a few left-field suggestions such as a world in which half the population spends all its disposable income on health insurance thanks to a poor result in a genetic test. And then I mentioned cyberterrorism. Many people downplay this, citing firewalls, encryption, etc. and saying that governments have better ways of causing trouble. But this underestimates the human role in setting up such firewalls, encryption, etc. and ignores the role of the lone hacker with a grudge or a mental problem, there doesn't need to be any government sponsorship. The Ambassador said he wasn't worried. He then gave the unfortunate example of flight. "If computers went down my plane ticket could very easily be printed out the old-fashioned way," he said. I asked if he would really feel safe flying when the plane's computer went down. He stared at me for a few seconds with a confused look on his face. He then turned to the man on his other side and didn't speak to me for the rest of the dinner. P

High-frequency Trading: Where are we and how did we get here?

Mon, 28 Jun 2010 10:30:00 --0100

"The truth is the high-frequency traders create volatility and create liquidity," said John Damgard, president of the Futures Industry Association. What he apparently meant to say was that they reduce volatility, not create it. And this was just a slip of the tongue. As Sigmund Freud observed, such slips can reveal the reality. I am concerned about High-frequency Trading (HFT) for two main reasons: Reduction of the relationship between value and price; Potential for positive feedback. Markets exist to enable businesses to raise money, to expand, to thereby employ people, and so on, for the benefit of society. This only works if the market does a decent job of revealing the true value of a company via its share price. Otherwise the market is no different from a casino, a share price may as well be given by the spin of a roulette wheel. Fundamental analysis is supposed to do a similar job. You analyze a company, study its customers, research the management, etc., and come to a conclusion. But fundamental analysis is hard work. Much easier is to run a data feed into a black box containing some algorithm, then optimize that algorithm. Your HFT black box doesn't care a hoot about the true value of a company, it only cares about what happens to the price over the next few seconds. You may spend a few months setting up this black box the first time, but thereafter you can apply it to a wide variety of markets with relatively little effort. Just re-optimize for that market. (And we know from how market players are compensated that the question of whether or not the result is long-term profitable is of second-order importance.) Not so with fundamental analysis, each market is different, each requiring the same weeks of hard work. The above wouldn't matter if the HFT boys didn't dominate the market. Is it now 70% of trades on some exchanges are HFT trades? Whenever you have a bandwagon, such as HFT now is, then you have the potential for systemic risk and feedback. Remember the last bandwagon?the credit products. How did that one turn out for the world economy? To get feedback you need a quantity of traders following similar strategies. "They all have different strategies," you say. Perhaps true for a while, but nor for long. Traders copy each other mercilessly, and since people in finance change jobs every two years it doesn?t take long for ideas to diffuse widely. But feedback can be positive or negative. Negative feedback is when an up move in a stock leads to a sell signal, and thus a fall in the price, and a down leads to a buy, and thus a rise in the price. This dampens volatility. Positive feedback is when an up begets a buy, which causes the stock to rise again, causing another buy, etc. etc. And when a fall begets a sell, causing another fall, and further selling, and? So which is it? Does HFT result in a reduction of volatility via negative feedback or an increase via positive feedback? This is an easy one. If you are a hedge fund manager which of the following would you prefer? A or B? A. Low volatility. Shares go up or go down fairly predictably. No skill is required to make money, even by the man on the street. Hedge funds can?t charge large fees. B. High volatility. Very difficult markets, experts needed and can charge large fees. If a fund does well they make a killing because of the enormous profit they have made for their clients. But they are just as likely to lose all their clients' money, in which case?nothing bad happens to the fund manager. Yes, we are in that familiar territory of moral hazard. Of course the funds want to increase volatility and they have found themselves in exactly the place they want to be to make this happen. (BTW If you want the mathematics of feedback see PWOQF2 or read the paper The feedback effect of hedging in illiquid markets, (P.Schoenbucher and P.Wilmott.) SIAM J. Appl. Math. 61 232-272 (2000). It's all about the gamma of a strategy.) How did we find ourselves in this place? Because the HFT boys cleverly played the "liquidity card" at the right time. The argument goes along these lines: "When Mom and Pop want to sell off some of their portfolio to fund their retirement then they'll get a better price if there's more liquidity. So liquidity is good." True! For the shares they've held onto for 20 years they will indeed get an extra cent. Whoohoo! Break out the champagne! So you mustn't argue with the liquidity card. The more the merrier, right? Well, no. The fact that during those 20 years their shares have lost 50% of their value thanks to the Great HFT Crash doesn't ever get mentioned. One extra cent versus a 50% fall? Hmmm. Everything in moderation. The more liquidity there is, the more you rely on its providers, and the worse the collapse when that liquidity dries up. And who is in the position to both cause this drying up, and to benefit from it? Why, it's the HFT boys again! P