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On May 6, 2010, the Dow Jones Stock Index, at about 2:30 PM, fell almost one thousand points, before recovering when traders discovered that there was no real news justifying the crash in prices.
Mindless robotic trading on stock exchanges led to Fat Finger Thursday.
The day will forever be know as ‘Fat-Finger Thursday’, in remembrance of the first inclination to blame the crash on supposed mistaken data entry by some trader, somewhere.
Later, the authorities came out and declared that there was no “fat finger”, but that the cause for the anomaly was unknown and under investigation.
Let the fat-finger-pointing begin
The bureaucrats at the SEC, who were not even able to spot the Madoff fraud when tipped off, and the professional politicians in Congress, who themselves were mainly to blame for the much more serious Crash of 2008, will now engage in lengthy investigations of the cause of the thousand point spike, until their minds wander off in pursuit of some other regulatory quarry.
Although it may be difficult to spot the exact trade or series of trades that caused Fat-Finger Thursday, the general cause is already obvious.
Over half of the trading volume on the world’s major securities exchanges is undertaken not by flesh-and-blood traders following the supposed dictates of the Efficient Market Hypothesis, but rather by robots — computers programmed to buy and sell securities at lighting speed, without human intervention, with decisions based on who-knows-what algorithm, programmed by who-knows-who, and triggered by price and volume moves in this or that security or derivative.
The basic concept of ‘program trading’, as it is called, is to find some find some anomaly is successive trades that will allow the owner of the trading robot to screw some excruciatingly slower, less well financed human investor, working only on brain power, out of a few dollars or even a few million dollars.
These robot traders are not bound by the old-fashioned ethics that Adam Smith assumed would rule capitalist systems. They are not even bound by laws against price manipulation or securities fraud, because, being robots, they cannot be read their Miranda rights or hauled before a Grand Jury. They cannot have ‘criminal intent’ because they are not human.
The owners of these robots will also get off the hook because the SEC has never bothered to regulate the programs of these robots.
If fact, the SEC bureaucrats are probably not even smart enough to regulate such programs. Besides, with over half of trades being done by robots, to outlaw robot trading would drastically reduce broker-dealer income, leading, perhaps, to unemployment on Wall Street.
Furthermore, since the majority of trading is conducted by robots, any particular robot owner could hardly be presumed to be acting recklessly, especially when the cause of ‘Fat-Finger Thursday’ is likely to be found to be related to the unintended consequences of the interaction of different robots, each programmed independently, by different programmers acting under different theories of competitive advantage.
The SEC should read Asimov
In 1942, Isaac Asimov wrote a science fiction short story, ‘Runaround’, that put forth the Three Laws of Robotics:
Isaac Asimov proposed the Three Laws of Robotics in a short story in 1942,
- A robot may not injure a human being or, through inaction, allow a human being to come to harm.
- A robot must obey any orders given to it by human beings, except where such orders would conflict with the First Law.
- A robot must protect its own existence as long as such protection does not conflict with the First or Second Law.
Of course, these three ‘laws’ were never enacted by a real life legislative body or any securities market regulator, which is why we now have ‘Fat-Finger Thursday’.
Although the SEC regulates in excruciating detail proper behavior for a human ‘tippee’ who overhears some ‘inside information’ at the country club locker room, it is breathlessly silent when it comes to the behavior of robotic traders.
The First Law of Robotics does not apply to Wall Street robots that are free to harm human beings without restraint.
The end of efficient markets
All of economic theory is based on the presumed interaction of human beings.
There is no ‘economics of robotic interaction’ for the simple reason that there is no standard robot. Each robot is different, programmed by different people, subject to different design flaws and programming errors, and based on various trading strategies, none of which can withstand scientific scrutiny.
An army of robots, each programmed differently, by different programmers, leads to unintended consequences.
Fat-Finger Thursday was that ‘ah ha moment’ when it suddenly became clear that the whole market was based on fantasy trading, divorced almost entirely from the real world.
We start with the so-called index funds that are not governed by rational selection of investments, a la Graham & Dodd, but rather by arbitrary investment formulae.
Next, we add derivatives of index funds, and on top of these, derivatives of derivatives of index funds.
Finally, we turn over the majority of buy and sell decisions with regard to these fundamentally irrational investments to an army of robots, each programmed differently, without regulation or care for human consequences.
On top of this, these robots are engaged in arbitrage across markets and national borders, without strict observance of credit rules and with multiple settlement conditions.
When asked to explain their actions, the owners of these robots first claim proprietary rights and secrets and then, if this doesn’t work, turn over tomes of mathematical equations and programming algorithms that, taken separately, are virtually impossible to understand, but when taken in context with the facts about hundred or thousands of other robots, each programmed by different people, become truly unfathomable.
The solution to the problem is simply to outlaw robotic trading, but don’t hold your breath until that happens.
What do you think?
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