Artificial Intelligence in the Forex Markets

AI Machines (aka computer algorithm robot) in forex trading are basically traders that execute trades at the speed of light based on a set of pre-programmed conditions. Estimates from different sources state that high-frequency trading (HFT) volume accounts for roughly 60% to 90% of the entire US equity markets.

Today, not only are these robot traders everywhere in the markets, but they have also literally transformed the entire operation of how financial markets are traded.

Evolution of the Stock Market

The US stock market began in 1792 with the twenty-four men who founded the NYSE. For nearly the next two hundred years the NYSE virtually maintained a monopoly on stock trading. Like with most monopolies, the NYSE was no different and had its fair share of corruption, charging high fees, offering inflated prices, and trading on secret deals.

Computer-aided trading was changing the old rules, however, and a new age of trading was on the horizon. It was believed that the introduction of computers into the markets would cut out the middle man, thus heralding a more efficient marketplace. However, what evolved with computers and technology was a totally new breed of traders –and one that has brought about a new intermediary: out with the floor broker, in with the high-frequency robot trader.

As computers started to enter the markets, there was a fresh, new wave of optimism among investors who wanted to see the “controlled” markets move away from the traditional bigwigs to a more decentralized and level playing field. At least this was the intent of one of the first great pioneers, Joshua Levine, who helped shape the market structure we know today.

Computers were supposed to provide investors with a higher level of market transparency, efficiency, and cost effectiveness in comparison to its older model of using floor specialists. In essence, Levin’s plan was to break the market free from its owners, and it worked for a while…

Investors jumped into computer trading with the added benefits of lower costs and faster fills. Levine’s creation of one of the first electronic communication networks (ECN) Island in the early 90’s and Puttman’s ECN creation of Archipelago (ARCA) began the greatest electronic trading pools of the time, which undermined even the NYSE and NASDAQ exchanges.

As computers started to become increasingly faster, the speed of trades inadvertently created a new breed of trader–the robot. Although these HFT robot traders do provide the market with liquidity and make the market more efficient, they have created other issues, such as the robot traders that front-run large institutional orders on the marketplace.

Think of all the pension funds and institutions: when they place their large orders to buy or sell, they get shortchanged a few pennies or more for every share they send in. Specialized robot traders are able to sniff out these large players in the market and beat them in speed, the will “skip the line,” so the speak, of the pending order queue when a large orders are placed. The end result can be significant over the long run for a pensioner or, in fact anyone investing in mutual funds.

robot trader

At the start of the new millennium, the stock market was temporarily liberated from the bonds of the NYSE and NASDAQ, however it did not last very long. In 2006, the NYSE took back its control of the market by merging with ARCA, while NASDAQ merged with Instinet (Instinet had acquired Island a few years before). The tables were turned once again to their “rightful” owners and we must trade again by their rules. The forex market is a decentralized market place, however, HFT traders exist even in this market.  

Cause and Effect of a Digital Marketplace

“Markets can remain irrational, longer than you can remain solvent.” John Maynard Keynes

In the 1950’s and 60’s the average holding time of a stock was measured in years and its price was largely based on the fundamentals of a company, such as earnings, profit, growth, etc. Of course, we know that there were exceptions to this.

Today, however, with the advent of machine traders, the average holding time is now measured in days, and sometimes even less. . Today, markets are heavily manipulated and distorted from their fundamental intrinsic value. It no longer matters how much debt you have, how low your earnings are, or what your growth is, for what matters most is Wall Street’s desire to push stock prices up or down, with the help of governments and central banks by lower the cost of borrowing. The markets have lost their core ability to correctly assess real value, and have plundered the majority of the middle class in their desire to benefit the few.

There is no doubt that the markets can be a lot more volatile now than ever. If you take an event like the 2010 flash crash or when the CHF got de-pegged from the Euro in the early 2015, you would know what I mean about volatility. Moving forward, with a digital marketplace infiltrated with robot traders extreme volatility at times is to be expected.

Meet Some of the Machines

Some people might be wondering what exactly are these machines. Well, there are many out there. Some call them “expert advisers” (EA), software programs designed to fulfill a specific task such as buying when a condition is met. On this blog, these are not the real robot traders to which we are referring when we say “machines”. Real machines are a lot more sophisticated in nature and could make billions of dollars in a week.

In essence, the machines we refer to on Dream World Forex were created mainly by the Agents of the Fed, like the HFT algorithms created by the New York Fed or the robot traders designed by the major banks and institutions to front-run the markets. In other words, these are robots that can place trades in extremely high volumes by and for institutions that are siphoning profits from, for instance, pension funds.

Entering the world of robot traders is extremely dark and unregulated. Most of the robots function over dark-pool electronic communication networks where transactions remains anonymous. Just to provide a glimpse of some of the high-profile known robots out there in the markets, consider the list below:

Renaissance Technologies: Considered the kingpin of HFT trading, it uses complex mathematical models to execute trades; currently has more than $22 billion under management.

Citadel: As of Feb 2015, it has about $24 billion under management, making it one of the world’s largest alternative asset managers.

Automated Trading Desk: Owned by Citigroup and trades about 200 million shares a day.

GETCO: Now called KCG Holdings, it trades in over 50 markets around the world and is consistently among the top 5 participants by volume on many venues.

Tradebot: Accounts for roughly 5% of the total U.S. stock market volume.

Rgmadvisors: Is a quantitative trading firm that applies scientific methods and computing power to trading in equities and futures.

Rebellion Research:  Employs machine learning in its algorithms to trade the financial markets.

ExitPoints:  Developed artificially-intelligent trading systems for the futures markets. 

Tradeworx: Has about $10 million in capital, and accounts for about 3 percent of daily volume in Spiders (SPY index).

Tower Research: Develops proprietary trading algorithms by using rigorous statistical methodology to identify non-random patterns in the behavior of markets.

IMC: Has two businesses, which operate independent of each other: Financial Markets and Asset Management.

Future of Robot Traders

What is NOT commonly known is that a new breed of robots is emerging in the financial markets, one that is learning from past successes and failures, much like humans. These artificial intelligence (AI) robots even source the news, social media, and every other transaction in the market in order to better base their investment decisions. AI is no longer a thing of the future, at least not for the financial markets.

Technological advances in finance and the stock market, specifically those relating to algo-trading, have increased speed, connectivity, reach, and complexity while simultaneously reducing its human interaction. Computers running software based on complex algorithms have replaced humans in many functions in the financial industry. In the markets, robots are having an increasingly more important role – transforming modern finance into “cyborg finance.”