Is that a Black Swan circling overhead?
In an earlier post I linked to a report from the UK about a forecast that the in the near future human traders will be replaced by automated systems. Yesterday I ran across a Wired Magazine about another study recently posted to arXiv that complements that earlier report by studying the possibility that high-speed computer trading may lead to sudden, unexpected fluctuations in our money machine that traders don’t understand and can’t react fast enough to do anything about. It has already happened. You may remember that on May 6, 2010, amid all the other financial problems of that year, the stock market suddenly lost 600 points in six minutes. This was the fastest, deepest drop in history. Nobody knew why and it tool a lengthy investigation to conclude it was one automated trade that triggered a cascade of automated sell-offs. It earned the newly-coined term “flash crash.”
This new study titled “Financial black swans driven by ultrafast machine ecology,” basically “black swans” happen a lot. A black swan is an event that is extreme, rare and unexpected. The consequences can be severe. But the researchers looked at trading data for events that were either significant drops or significant spikes in prices that happened in less than one second (less that .65 seconds, to be exact). That’s faster than a human being can perceive and react. (Like what, hit the PANIC button?)
The researchers analyzed 18,520 drops or spikes that happened in less than second between 2006 and 2011. Yes, these events are no longer rare. They happen all the time in computerized trading, and the volume of computer trading is growing every day. “Black swan” no longer really applies to these glitches. Nobody understands what’s going on in the global financial trading system well enough to understand what’s not a problem and what is. We may get a really ugly lesson when one of these events doesn’t self-correct and instead creates another huge flash-crash, and we are thrown into a financial crisis with all it’s attendant misery.
Do you know where your money is tonight?