January 17, 2012

Algorithms Are Pragmatic Chaos

Despite Denver’s rude throttling by the New England Patriots, I am still bound for Boston to panel at the Wednesday NIRI chapter meeting called “A Day in the Life of a Trade: How Can IROs Know What’s Really Happening?” Hope to see you there!

One of our technology geeks shared a link at TED, the place where nerds of a commonly self-aggrandized feather gather to bloviate about culture. In this one, Kevin Slavin, founder of a game-hatching thought shop bought by Zynga, discusses how algorithms run our world. The guy is a good speaker and knows his imagery. Of algorithms, he says: “We’re writing things that we can no longer read.”

Slavin sets up his piquant point this way. He was on a flight with a Hungarian physicist who’s on Wall Street writing algorithms. The Hungarian used to work for the Soviets using math and physics to find American Stealth aircraft. Apparently, technology dissolves the signature of Stealth planes into a million fragments so they won’t look like planes to radar. The Hungarian wrote equations to find electronic tidbits hiding planes.

Lo and behold, Wall Street is doing the same thing. Institutions are using algorithms to break down their stealth moves to buy and sell shares into a million pieces so they don’t show up on anyone’s screen. They’re hiding the aircraft, disguising the elephant. And a whole bunch of other algorithms are out winnowing signals to assemble patterns that show where elephants are pirouetting across putting greens.

I thought professionals in the IR chair could use this imagery. It’s not new to us. But it’s a way to explain trading to execs. Slavin notes how this activity comprises the great majority of volume, one part hiding what it does, the other trying to discover it. As he says, “This is your pension, your 401k, your mortgage.” And: “We’ve lost the sense of what’s actually happening in this world we’ve made.”

Something else struck me. Slavin relates a vignette from an auction at Amazon for a book out of print. The price goes from $1.7m to $23.7m. Nobody was buying or selling the book. No human said, “You know, $1.7m is enough really.” Machines were in combat, applying what Netflix calls pragmatic chaos. Choreographed machine rationale without common sense can imagine demand or recommend movies for you.

It can also assign prices to stocks. Algorithms assemble and fragment things. The things have no inherent value. Prices are zeroes and ones blended and dissolved at speeds many times faster than the click of a mouse. Numbers, grids, patterns, probing. It’s hide-and-seek. It’s Stealth warfare.

And here come earnings again. Everybody will look at the market for a sense of what investors think. We can’t even read what we wrote. Pragmatic chaos.

Regulators are trying to make a big Off Button to press on the inevitable day when pragmatic chaos picks incorrectly. Maybe we should just unplug it.

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