Algo-mania: The machines take over Wall Street
NEW YORK (Reuters) - Louis Morgan, managing director of hedge-fund firm HG Trading, has never talked to his best trader. That's because his best trader is a machine.
Morgan's top earner is a computer whose software can monitor thousands of stocks simultaneously, and respond in less than a blink of an eye when opportunities arise.
"Doing what we do by hand would be impossible," said Morgan, who focuses on statistical arbitrage -- taking advantage of sudden and potentially profitable price anomalies between securities that usually trade in correlation.
Morgan uses a computer trading system based on algorithms, complex mathematical formulas that quickly weigh a huge number of possible trades and execute orders in milliseconds (a millisecond is one thousandth of a second).
He is part of a rapid and relentless trading revolution that in just a few years has transformed financial markets.
The increasing adoption of algorithmic trading -- "black box trading systems" -- is changing the way Wall Street works and is creating new royalty with billion-dollar-plus incomes.
Former math professor James Simons, who was one of the best paid hedge fund managers in the world last year, earned $1.7 billion, according to Alpha magazine.
But even as such kings ascend, there are predictions that the number of traders will sink by as much as 90 percent by 2015 and that most of those who will be left won't need traditional Wall Street skills but will be whizzes in math, statistics, computer science, astrophysics and linguistics.
In short, they will have many of the real abilities of a rocket scientist.
The presence of so much computer power has so far reduced short-term market volatility, but it also is giving regulators sleepless nights.
Many wonder what would happen if a rogue trader with rocket-scientist skills had control of a Wall Street firm's black boxes, or if the machines turned a market slide into a meltdown before anyone could trigger a halt.
The change is even affecting where big banks and funds do business as they seek to get physically closer to exchanges, and even news services, so they don't lose precious seconds through lags in transmission of data, information and news.
And financial news organizations are increasingly focused on machine-readable, as well as human-readable news.
GOING MAINSTREAM
About a third of U.S. equities trading is already being done using algorithmic trading, with that figure expected to soar to more than 50 percent by 2010, said Brad Bailey, a senior analyst at the Boston-based researcher Aite Group. Continued...
