An ultrafast all-machine phase in which machines dictate price changes
The futurist Ray Kurzweil has famously predicted that humanity is approaching a “singularity,” a fateful moment when our technology becomes smarter than us and able to learn faster than we can, when it becomes the principal creator of new technologies and machines race far ahead of us. Humans may effectively fall out of the loop — a species demoted, if not eliminated.
For now, this world remains science fiction, at least at the level of humanity. But finance is flirting with a similar transition, as ever-faster computing and communications technology takes high-frequency trading into a regime of speed where human beings can no longer keep up. In fact, we may have already arrived.
The Flash Crash of May 6, 2010, was a landmark event hinting that something may be amiss in the high frequency markets. Now it is clear that odd market behavior at high frequencies is systematic.
In a recent study, physicist Neil Johnson and colleagues found more than 18,000 instances over the past five years where markets, in about a second and a half or less, either ticked up or down at least 10 times in a row, making prices rise or fall in that span by more than 0.8 percent. Many of these mini- crashes and mini-booms took place in well under a tenth of a second, effectively instantaneous from a human perspective. And they have been happening roughly 10 times per day. It’s as if the markets are throwing off sparks reflecting mysterious frictions or stresses.
These sparks show up in market statistics, too. The same study looked at the incidents on different timescales, both above one second and below, and found a striking difference. Over periods of one second or longer, the distribution of events by size has the familiar “fat tailed” distribution — the norm for markets, broadly speaking, which reflects their pronounced susceptibility to large price changes.
In contrast, the distribution for events that last less than one second looks very different. Here, the distribution is “fatter than fat” and shows an even greater than normal tendency for Black Swan-type upheavals.
What’s so special about one second? Why is this sharp and distinctive boundary located at that period of time, rather than at, say, one minute or a 10th of a second? Well, it is more than a little suspicious, the researchers point out, that one second happens to be right around the speed limit for fast human decision making. Experiments with chess grandmasters, for example, show they can assess a complex chess situation and identify a threat of checkmate in about two thirds of a second. Other people operate at comparable speeds in their own areas of expertise.
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