Gambling across borders

A blog about the productive life of risk

Posts Tagged ‘spread betting industry

Beat the algorithms, the casino and the spread betting company

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As I wrote in an earlier post in April, High Frequency Trading (HFT) is perceived as making financial markets even more inhuman and evil than they already are. HFT has truly become the black beast of financial markets. Condemnations of HFT under such metaphors as that of an ‘hyper-speed casino’ bring to the table an interesting question: Is HFT making the market a more unfair game where a few players have a considerable technical advantage over the majority?

It is true that HFT is about working out gaps in the market and grabbing those opportunities to make profit. Being faster and being able to make many more trades than other traders is an obvious advantage since not everyone can afford it: keeping in the game of HFT is costly in investment and expertise.

It would be a mistake though to ascribe too much importance to those ‘supposedly smart machines’, a point that Michael Stothard raises in a recent FT article. After all, HFT and the algorithms behind it are not infallible. In the same manner that the dealer can be beaten by counting cards at blackjack, the algorithm can be beaten by spotting its failures.

Stothard tells us the story of how in 2007, a Norwegian trader, Svend Egil Larsen spotted a weakness in the computer system of Timber Hill, a unit of Interactive Broker. He found out that their algorithm reacted to trades in certain illiquid stocks and that he could take advantage of this by moving the price to his advantage to buy low and then sell  at a profit. Larsen made $50,000 in a few months but he was not the only trader to be operating in this way. Another trader, Peder Veiby, was also playing the ‘system’. Both Veiby and Larsen have since been charged with market manipulation. The most interesting point of this case is not so much that they beat the algorithm or were charged for it but that the courts has ‘found them not guilty, concluding that they were making the market more efficient by exposing a flaw in the system’.

This reminds me of the case of a spread better Barnett Alexander who was charged by the FSA last year for market manipulation for similar reason of price manipulation based on flaws in the spread betting companies. However, despite the case of Larsen and Veiby and the fact that they were cleared, Barnett Alexander preferred to avoid court. Instead he decided to settle with the FSA for £1.3m, a compromise, bearing in mind the potential costs of a lengthy court case were he to lose. Despite this however Alexander still believes that he could have won and as he rightly pointed out to me in an interview, technically he was not manipulating the market but the spread betting company’s prices. The distinction he makes is an important one and indeed, it makes the Swedish case even more interesting.

Barnett Alexander’s case is actually more similar to Larsen/Veiby than one might first imagine. Although Interactive Broker doesn’t call itself a spread betting company, it offers Contract For Differences which work on a similar principle to spread betting. In short, Interactive Broker offers a similar trading experience to Swedish traders than spread betting companies to British customers based on prices indexed to those of the market. This means that although traders have the feel of trading in the market they’re actually trading in another market: that the prices offered by spread betting companies and other financial institutions offering spread betting and CFDs. What those traders have found is that despite the fact that buying and selling stocks as spread betting or CFDs doesn’t affect the movement of share prices in the market (since no actual share is actually bought or sold), the reverse is certainly true: share prices in the market affect the prices offered by spread betting companies.

It seems, after all, that the comparison of HFT, or rather algorithms, to the casino has more to offer than merely a reference to unspecified evils. It’s important to underline here that the gambling industry also uses algorithms to facilitate random conditions and make prices for bets. Like spread betting companies, bookmakers, casinos and other gambling businesses are market makers, and although the house, in principle, will always win, it doesn’t mean that it cannot be beaten.

Written by Claire Loussouarn

May 28, 2012 at 7:06 pm

Has Wall Street become a hyper-speed casino?

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On 6 May 2010 the Dow Jones incurred a fall of 1000 points in 15 minutes to rally back in another 15. This event, now referred as the ‘flash crash’, has brought High Frequency Trading (HFT), the use of computer technology to trade at increasingly fast speed in order to take advantage of tiny opportunities in the market, under harsh scrutiny and criticism.

The CFTC, the US regulator in charge of the commodities market, has recently settled a case court against Optiver, a high frequency trading company with a $14 millions deal. Optiver’s Chicago office was accused of having reaped a $1 million profit by engaging in a practice called “banging the close”, in which the firm attempted to move U.S. oil prices by executing a large volume of deals during the final moments of trading. The Optiver case is revealing of the new CFTC’s will to crackdown on market abuse and HFT.

Others in the industry call High Frequency Traders ‘parasites’ which have turned Wall Street into a ‘hyper-speed casino’ by taking all the humanity out of what used to be a very human business. The anxiety towards high-frequency trading has even recently lead to plans to create new exchange-type platforms which will exclude high-frequency traders.

Is High Frequency Trading the new evil face of Wall Street?

David Levine at the Huff Post has written the most compelling and insightful article I have read so far on the topic. His account demonstrates that the question of High Frequency Trading hides much bigger ones and cannot be answered in a straightforward manner.

The criticism that High Frequency Trading takes the social out of trading reminds of what Rebecca Cassidy, an anthropologist, says about the rise of technology in gambling.  She argues in her article Horse versus Machine: Battle in the Betting Shop, forthcoming in JRAI, that the arrival of machine gambling in the betting shop doesn’t lead, as it is frequently claimed, to asocial forms of gambling. She explains, on the contrary, how betting shop customers innovate through new gambling media.

In some instances, betting shop regulars ‘gang up’ against a specific machine. Every member of the group invests an amount of money, the machine is played in turn, and winnings are shared according to one’s investment.

By interviewing and depicting one of those individuals who are behind the computers, David Levine makes a similar point: High Frequency Trading is not just machines without faces.

The argument that technology kills the social nature of trading is not new. In her book Out of the Pits: Traders and Technology from Chicago to London, Caitlin Zaloom, another anthropologist, depicts how, at the turn of the millennium, financial markets left behind the chaotic gesture of trading floors for numbers on screen and how traders’ role did not disappear as a result but was redefined in interaction with these new technologies.

What is striking in David Levine’s article is how Gorton, the speed trader, doesn’t see himself so much as a trader anymore but rather as an engineer. In his own words, here is how he describes the company he runs: ‘We’re really an engineering company. We have a lot more in common with Google than we do with one of the big bank’. This is exactly how spread betting companies in the UK have been described to me: as IT companies first, trading coming second. IG Index epitomizes this rhetoric by employing 350 staff in IT, a third of its workforce worldwide.

Technology for sure plays a central role in trading which is constantly growing and that we can’t ignore. Calls for more regulation on HFT do not take into account the practical difficulties to regulate it, ignoring to address the politics at work behind technology. Questions which ask whether it is evil are unhelpful and fail to articulate the resourceful and rich manner individuals redefine what they do in interaction with technology.

Written by Claire Loussouarn

April 20, 2012 at 2:37 pm