Your portfolio
blamed to some extent for corrections
of every shape and size in recent
years. However, while the market
tends to quickly rebound from these
temporary setbacks, is there a danger
that algorithms could eventually pose
a long-term threat to investments left
on “autopilot” in tracker funds?
Christopher Gannatti, head of
research at WisdomTree, thinks this
is unlikely.
High-frequency trading
“Most of the time when the question
comes up about algorithmic trading,
it is under the umbrella of high-
frequency trading,” he says.
“A lot of work has been done on this
and it found the biggest issue for
these algorithms is the location of the
servers. You have these high-frequency
trading hedge funds for which money
is no object which spent vast amounts
of money on fibre optic cables in a
perfectly straight line between Chicago
and New York to ensure they had the
fastest overall trading experience.”
Gannatti says the reason these funds
are so obsessive about speed is they
use the algorithms for front running.
This means that through analysing
patterns they can determine whether
a large order is about to be placed for
a company’s shares, allowing them
to buy in first to benefit from the
subsequent uplift in value.
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“Having done it before,
you would have a trading
record as long as your arm
and high-frequency traders
would rip your legs off”
“The analogy you frequently see is
picking up pennies in front of a steam
roller,” Gannatti continues. “The
reasoning being that if you find a way
of making a tiny amount of money,
but you do this many times and have
a bit of leverage, ultimately you have
an attractive investment strategy.”
But with these hedge funds using
algorithms to profit from the actions
of professional fund managers,
surely it is only a matter of time
before a “pump and dump” version is
developed that could take advantage
of the vast amounts of retail investors’
cash flowing into passives?
For example, with passive funds
buying every stock on an index, an
algorithm could take advantage of
this by pumping money into one
stock, forcing the tracker funds to
buy it at the close of trading, pushing
up its price. The algorithm could
then short it and sell out, so forcing
the index trackers to sell out as well,
deflating its price – before repeating
the process ad infinitum.
However, when this question was put
to the experts, they said there was so
much wrong with it, they didn’t know
where to start.
Alex Tarver, analyst at QuotedData,
says the first problem is
that the market would
“see you coming
from a mile off”.
“Extraordinarily large pockets”
“The securities regulator and the
FCA would be all over it, because it is
market manipulation,” he explains.
“And you would need extraordinarily
large pockets to lift the share price and
keep it there. Having done it before,
you would have a trading record as
long as your arm and high frequency
traders would rip your legs off.”
However, while pushing up the price
of individual stocks like this would be
incredibly difficult – not to mention
illegal – in the likes of the S&P 500 and
FTSE 100, what about in more obscure
markets where the stocks are a fraction
of the size and the regulators take
more of a “hands off” approach?
Gannatti points out the problem
with this hypothesis is that although
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