So, Thomson-Reuters pays the University of Michigan a million dollars a year to provide selected clients with the results of the latest survey of consumer sentiment 5 minutes before the rest of the world sees them — and to provide higher-paying clients with this information in a machine-readable format ready for algorithmic trading 2 seconds before the rest.
This was not first revealed by the issuers of the consumer confidence survey, or by Thomson-Reuters, but rather by Nanex:
On May 28, 2013, about 1/4 second before the expected release of the Consumer Confidence number, trading exploded in SPY, the e Mini and hundreds of other stocks. Even more interesting, activity exploded just 1 millisecond earlier in the futures (traded in Chicago) than stocks (traded in NYC). The speed of light separates information between Chicago and NYC by at least 4 or 5 milliseconds. Which means this was more likely the result of a timed trading in both futures and stocks, rather than a arbitrage reaction between the two.
We found no other instances of early trading in the 11 previous monthly releases of the same Consumer Confidence data.
So, is having a two second jump on the market “insider trading”? Well, yes — but it’s legal insider trading with consent, out in the open. And it likely provides a valuable income stream for the University of Michigan. With or without an early information premium, the algorithmic traders would still have the jump on the wider market. A two second delay in the high-frequency world is an eternity. This kind of early information premium is more like a financial tax on high-frequency traders. If we’re going to have high-frequency trading at all, it may be better for publicly-funded information providers to be able to recoup some or all of their costs by charging the high-frequency traders. In fact, while high-frequency trading continues states might want to look at rolling this out across other datasets, and putting the proceeds toward infrastructure spending or some other public good. After all, while banning high-frequency trading makes for attractive rhetoric, it would probably send an even greater amount of financial activity offshore into a jurisdiction that allowed it. That implies that it would probably be about as effective as prohibiting marijuana and alcohol.
And is this financial markets going post-human? These kinds of barriers to entry cannot be healthy for inclusive, open, transparent markets. If there was anything that might drive retail investors out of the markets — retail investors remain significantly under-invested on where they were before the advent of high-frequency trading, for example — it is massive information asymmetries that render the little guy entirely uncompetitive. Of course, retail investors can still be fundamental value investors, buying and holding. But trying to daytrade against the algorithms seems analogous to a human runner competing against a Ferrari. In fact, given the timeframes (microseconds, in some cases) this analogy is many orders of magnitude too small; it’s closer to a human runner competing against an Alcubierre warp drive. Not so much picking up nickels in front of a steamroller as picking up nickels in front of a Borg cube. If this continues, trading is going post-human.
But in the long run — given how badly traders tend to do against the market — perhaps driving daytraders out of daytrading where they tend to lose money against the market, and into holding diversified index funds is a cloud with a silver lining. Let the robots read the tape (i.e. use regression analyses) and do financial battle. Robots are fast, they don’t get bored or discouraged. Just as in other areas where human endeavour is threatened by robots, it is important to note that while robots can do many things, there are many spheres where humans still have a great advantage. Let humans act in the roles in which they have a natural advantage, and in which robots do not have any skill at all — abstract thought, creativity, social interaction. Robots are still largely confined to drudgery; the word itself is rooted in the Czech word for drudgery, after all. In finance, while robots may some day soon do the overwhelming majority of the trading, humans can still devise the trading strategy, still devise the marketing and sales strategies, and still devise the broader macro strategy.
So perhaps the beginning of the end for human traders is just the end of the beginning for global financial markets. Perhaps that is less of a death sentence, and more of a liberation, allowing talented human labour that in recent years has been channelled into unproductive and obscure projects in big finance to move into more productive domains.