Hedge fund robots crushed human rivals in 2014

http://www.cnbc.com/id/102306617

by anacleto • 11 years ago

66 48 11 years ago

anigbrowl2• 11 years ago

These are interesting links, but 15 submissions in 15 minutes is way overdoing it.

leppr• 11 years ago

See that's why humans won't last long, can't even compute a little 7311 word data stream in 900 seconds. So invest in robots, ok? Robots are disruptive and future.

pcrh2• 11 years ago

But do the robots get bonuses...? I think not.

valdiorn2• 11 years ago

the people who build the "robots" (Algorithms, or trading systems are a more applicable name) do.

pcrh2• 11 years ago

Quite. So it isn't really robots versus humans, but one algorithm versus another, the humans are using a method too.

pfortuny2• 11 years ago

So apart from the first 6, they did as the DOW or less, which is not so impressive. Or is it?

valdiorn2• 11 years ago

depends on the sharpe ratio.

You can flip a coin every year. Heads; double your money, tails; lose your bet. You can easily win 3 years in a row (12.5% chance), but getting 800% return on that risk is literally worthless in the long run, as the chance of winning or losing is equal.

pfortuny2• 11 years ago

What I meant is... Those 'huge benefits of algorithmic hedge funds' depend on the number of algorithmic hedge funds: if there are enough of them, you will probably get some with outstanding results every year, won't you?

dualogy• 11 years ago

Overheard just earlier:

"Financial markets used to be about getting money into productive enterprises, not out of them"

Right on. Let all the leveraged bots and algos devour each other. Sooner or later "real economy" will decouple anyway. And with the savings of millions of individuals, pension funds and insurance corporations ping-ponging between botnets, the real "hedge" will be to remain liquid and competetive outside this hodgepodge when it all inevitably ends up belly-up.

kbody• 11 years ago

I can imagine in the future there may be a time where like the vinyls, "hipster" entrepreneurs et al. will try to create a bot-free stock exchange, because stock exchanges do have great value for businesses if not messed with meaningless profiteering.

CmonDev2• 11 years ago

That would have to be a pit with shouting and hand waving then. No computers.

NickPollard2• 11 years ago

There are definitely things wrong with financial markets, but automated trading is not one of them. Just like anything else, using computers to be more efficient is a good thing. Are you going to complain about Amazon and wait for 'real retail' to decouple?

The problem with modern financial markets is that they have become quite abstract. Finance is maths, which means it's code, which means you start abstracting away from the implementation to get to a high level. Just because it's not immediately clear to a layperson what's going on, doesn't mean it's not useful or real.

Imagine what would happen for most programmers if you tried to explain to a layperson what you do.

"I'm a developer"

"Oh, you make websites?"

"Well, uh, no, you see, I make tools for making it easier to make websites"

"Oh, like what?"

"Um, well I make a compiler for turning one language into another"

"Why?"

"Well, when you make a website, you have to do all this stuff, but, well, you could do less stuff, just more clever, and then it's easier and you don't have to worry about for loops and such"

"What's a for loop?"

"Oh that doesn't matter. But now we can use a monadic map instead, which is much easier, developers don't want to write loops, map is better. But Javascript is a bit fiddly, so now I've written another language, so you can write in that, and then you run my tool, and then you get Javascript, so the browsers can understand it."

"Oh, so the browser only runs Javascript?"

"Yes. Well no. Actually most of them run some kind of JIT compiler, which turns javascript into another language, and then they run that"

"So your language becomes another language which becomes another language? Why not just write the other one?"

"Well, because that's not really what we want to do, it's awkward, and inefficient, and bug-prone..."

"But your language isn't a real thing? No-one's actually using it? My computer never gets it, never runs it, never understands it? Shouldn't you be doing real development?"

CmonDev2• 11 years ago

It's easier: just like CEOs delegate certain tasks to underlings, developers delegate certain tasks to compilers and tools. So writing vanilla JS is like CEO cleaning own office and doing accounting. Possible, might be enjoined, but generally inefficient and annoying.

Zigurd• 11 years ago

While there is a lot to be said against "financialization" in an economy, this particular outcome isn't a signal that things are getting worse.

I'd be more worried if several humans were significantly outperforming algorithms over a significant amount of time because that is an unlikely outcome in an honest market.

Automation will also drive down costs.

gchokov• 11 years ago

"Nothing new under the sun" as we are used to say. Think is.. what will happen when even the small companies have enough processing powers and knowledge to implement such system. What value would any currency have. Scary to think...

minimax• 11 years ago

So-called managed futures funds — which trade the futures contracts of stocks, bonds, currencies and commodities — gained an average of 15.2 percent last year, according to Societe Generale unit Newedge.

This probably isn't obvious to people outside of the trading world, but Newedge is a massive futures broker. This article is basically a puff piece quoting a big futures broker telling you how great it is to trade futures. I wouldn't read too much more into it than that.

_sword• 11 years ago

It's reported by CNBC, which almost exclusively puts out puff opinion pieces when its not reporting financial results.

bsdpython6• 11 years ago

"The biggest gains came at funds that practiced a "trend following" strategy. Those managers—who use computer models to bet on price movements in either direction and often perform best when clear patterns emerge over several months"

This is headed for 2008 all over again because we've learned nothing. These algorithms rack up consistent wins for years on end, the markets rise and rise, everyone gets bonuses and all is great. Then the market turns on a dime, all the computer algorithms break at once because chaos theory takes over and your trend algorithms are useless. Liquidity disappears in an instant and the the federal reserve steps in and gives away free money to the banks until the banks become solvent again. This will continue until the parasite kills the host.

apaxmd• 11 years ago

Vinod Khosla once said he was shocked at how good of a deal VC funding was for the entrepreneur. "Heads I win, tails you lose." It's the same thing for bankers, traders, and managers of 2/20 funds. If things collapse, they're already rich. Sure, it might be difficult to raise another fund, but if you've already stashed $10mm+, who cares? Gambling with other people's money, therein lies the incentive problem.

jim_greco• 11 years ago

Algos didn't cause the '08 crash. The '08 crash was caused by a lot of bad bets on the housing market. 100% of those bets were made by humans chatting on Bloomberg or over the telephone.

Edit: No, child posts, you cannot make the leap that trend following algos are the same thing as modeling MBS risk (which isn't an algo...).

Retric2• 11 years ago

Garbage in Garbage out. Algos directly caused the '08 crash (lot's of things where indirectly responsible though). Software Algorithms designed to model risks did not take into account a down economy which systemically undervalued risks leading to lots of over leveraged institutions to fail. Arguably, many of the people writing the software where instructed to 'tweak' their models to the point of uselessness.

One of the major failing of modern statistics instruction is 6+ sigma events don't look like 1-5 sigma events. Case in point global death totals per second probably fit a very well defined curve, but Hiroshima and Nagasaki where well outside that curve.

bsdpython6• 11 years ago

See my other answer here but basically I see all of these things as the same: find a trend, abstract it with algorithms/risk models, exploit that trend and then walk away when the trend inevitably breaks.

murbard23• 11 years ago

Nice story, except the 2008 crisis happened in subprime mortgages backed securities, for which there were no such strategies. What you're describing sounds a bit more like the 1987 crash, which was linked to portfolio insurance strategies, which have far more insidious consequences than trend following (and have since then been deprecated).

bsdpython6• 11 years ago

Replace "stock market" with "MBS/CDO type derivatives" and "computer trading algorithms" with "risk models" and you will see the similarities. I probably should have been more clear but the idea is that all of the financial markets work basically the same way: find a trend, abstract it with algorithms/risk models, exploit that trend and then walk away when the trend inevitably breaks. Every 10 years we keep having "10,000 year floods" according to the latest whiz-bang model/algorithm. It's all the same thing in a different variety.

marcusgarvey• 11 years ago

Agree. Everything gets amplified, whether that be to the upside or the downside. George Soros has a book about this [1].

Also, one big issue in 2008 is that no one thought so many different asset classes would be correlated together and so many were caught out when the market devolved into just 2 meta asset classes : "risk-on" and "risk-off". Can the algorithms account for this?

Can they also account for the fact that we have never seen such a persistently low interest rate environment in so many major economies at the same time? Or is that off-model? Looking at their human counterparts, a recent article speculated that it has been going on for so long, and there has been so much turnover at the financial institutions, that there may be many young traders who literally have no experience of what happens when interest rates are put to more normal levels.

Things like the major dislocation from the Swiss franc devaluation show the fallibility of trend following models that fail to capture the known-unknowns:

"When the “off-model” event was the breakdown of parts of the wholesale money market in 2007, their surprise was just about forgivable: in the case of the Swiss revaluation [which even Goldman Sachs called a '20-plus standard deviation' occurrence], to have failed to visualise the possibility is rank incompetence [2]."

-- [1] http://abcnews.go.com/Business/story?id=4842282&page=1&singl...

[2] http://www.ft.com/cms/s/0/5a06ef16-b5e4-11e4-a577-00144feab7...

parados• 11 years ago

This is headed for 2008 ... and your trend algorithms are useless.

Wrong. Trend followers did extremely well in 2008-2010. As the article says it was the years 2011-2013 that they struggled with.

ssharp• 11 years ago

These things have kill switches built-in, don't they?

My question would be, what happens to the markets if there is a quick fall, the algorithms shut down, and all the HFT liquidity is removed?

beagle3• 11 years ago

These things have kill switches built-in, don't they?

Not all of them have kill switches - Knight Trading had something with no kill switch that cost them $400M in a matter of hours. (It wasn't even a trading program - some kind of simulation system that was erroneously allowed on the real market).

You could say "it didn't need a kill switch, because it wasn't a trading algo!". But many trading systems are made of small parts that can break, and you only know your kill switch works after it saved you - otherwise, it's just an "untested feature before QA".

My question would be, what happens to the markets if there is a quick fall, the algorithms shut down, and all the HFT liquidity is removed?

We've seen such mini events before. We see what's known as a "flash crash" (price goes down significantly within seconds, only to come back to more or less the same place), or alternately, a "flash smash" if it goes up (to come down later). This has been happening since 2007 at a frequency of about once every two months. Sometimes trades happening during the flash {sm,cr}ash get retroactively canceled, and sometimes they do not.

busterarm3• 11 years ago

If it makes you feel better, my (quant and infrastructure) friends who work at algo firms that did phenomenally well this year all got bonuses way below what they were expecting.

People are pissed and jumping ship. There's way more people than there are positions available because the industry is contracting/consolidating.

Sure, the algos performed well this year, but these are the firms that survived. Lots of players got crushed playing the algo game and are no longer willing to play.

foobarqux• 11 years ago

Are those who left staying in finance?

xyby• 11 years ago

"...beating most gut-driven human managers and dramatically recovering most of their losses from 2011, 2012 and 2013..."

http://xkcd.com/904/

spot• 11 years ago

Two Sigma is hiring javascript developers to build open source research systems (the tools used by the quants to build the AIs): http://beakernotebook.com/careers

n72• 11 years ago

So they "crushed" other hedge funds? They returned 15.2%(1). You know what, boring old VTSAX returned 12.6%(2). Given the risk involved, VTSAX was a much better play. Ugh, hedge funds are suuuuuuuch a rip off.

(1) Don't know if this includes fees (2) Don't know if this includes dividends

chrisgd• 11 years ago

I would guess the 15.2% does not include fees and the 12.6% does not include dividends. Probably even closer after that.

_benedict• 11 years ago

Trend following futures models typically have a very high variance in returns, so yielding above market returns in 1 year out of 4 is not significant or meaningful.

Hedge fund robots crushed human rivals in 2014

Related Stories