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Since auctions are a key form of price discovery , lack of participation is likely to have an impact on the market once the auction is over , Ross contends . He points to post-volatility auction trading volumes and price moves which were significantly higher compared with the first minute of trading after a typical opening auction : stabilisation has still not been achieved .
Some brokers were completely unable to support participation in the auctions . The most likely explanation , he believes , is that algorithms were not coded to handle such events . The algorithm “ only really knows what it has seen before ,” and so chose to sit the auctions out , leaving the markets to fend for themselves .
Managing an automated options market making model for about 20 years taught Steve Sosnick that successful algorithms “ need to be tweaked constantly ”. A shock that is beyond the normal scope of a model “ doesn ’ t invalidate the algorithms inside it , but it does force a larger re-evaluation of its underlying premises ,” says Sosnick , algorithms to be updated automatically in a changing situation , without human intervention .
The danger is that the speed at which these algorithms learn will outpace human capacity to manage and regulate them . According to a report in June from the International Organisation of Securities Commissions ( IOSC ), AI and machine learning ( ML ) can “ create or amplify ” risks for financial markets .
Regulators should consider requiring firms to have designated senior management responsible for monitoring and controlling AI and ML , the report says . Regulators should also require firms to continuously test algorithms to validate the results of the tech-
“ Uncertainty is the main source for volatility , and the context around COVID-19 is all about uncertainty .”
DEJAN ILIJEVSKI , PRESIDENT , SABELA CAPITAL
now chief strategist at Interactive Brokers in Connecticut .
“ Profitability should never take a back seat to risk management ,” he says . “ We learned the hard way who focused on reward without sufficient focus on risk .”
There ’ s no way that algorithms and HFT are going to go away , Sosnick adds . The key is managing control . Practitioners must “ maintain risk controls that work even in extraordinary circumstances ”.
Artificial intelligence Algorithms can be divided between those that simply follow the rules laid down in the programme , and those that are linked to machine learning and artificial intelligence ( AI ). In the latter case , the aim is for these “ self-learning ” niques used , the IOSC said . Further , compliance and risk management functions need to be able to understand and challenge the algorithms that are produced , and conduct due diligence on third-party providers .
Ross says the danger of market manipulation is “ a regulatory concern ”. “ The machine does not know the regulations . It could certainly come up with something that does not meet market norms .”
Still , he believes the same kind of dangers exist with human traders as with algorithms and “ it ’ s easier to shut down the machine than the human ”. Of course , rogue human traders are easier to prosecute once you find them . But who gets prosecuted when the algorithms go wrong ?
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