The great “Man vs. Machine” debate in the financial markets – The verdict is in!

October 1, 2018 Publications

In our view, The Man vs Machine Debate in the financial markets has always been a heated one. But we feel that is changing and that it is not so much of a debate anymore.

But First… let’s just get it out of the way – we view machines as the clear winner and believe that this trend will only strengthen going forward. Let’s dive in a bit deeper!

Don’t get us wrong, being human we are “cheering for people”. But the evidence is getting impossible to ignore; each year machines (algos) are continuing to get smarter and continuing to out-perform manual traders… exponentially!

If you asked us this even 2 years ago we would have probably said it’s a “toss up” but the data is becoming overwhelmingly one-sided, and the amount of trading volume switching to algo sources also strongly supports this.

It seems that traders are simply going with what works. According to both EBS and Morgan Stanley via the financial times, the ratio of algo to manual traders in 2010 was approx. 70:30, in 2012, it is 84:16, in 2014 it was 89:11. We don’t have these ratios in 2018 but we can only assume the trend is continuing further. This shift naturally creates a lot of distortion in the market, and ultimately changes how it behaves – magnifying an already arduous problem and increasing the difficulty for manual traders to navigate markets the way they used to in “the good old days”.

Fewer manual traders are able to CONSISTENTLY out-perform algos and we expect this trend not only to continue but to exponentially intensify. While the machines are fighting people try the automatic system to trade bitcoin up.

This doesn’t mean that the “human element” is entirely removed; algo trading isn’t some sci-fi movie robot sitting at a desk and trading the markets, but rather proud/brilliant/creative teams of coders and mathematicians essentially looking to “solve the problem” of how to profit from the markets using a unique tool-set.

These people are writing computer programs to do the heavy lifting for them. Most are still deeply engaged in their work but don’t require the same amount of “screen time” and most importantly they don’t need to worry about emotion (trading is one of the few tasks in the world where emotion is proven to be a detriment).

There are things that computers will likely never do better than humans – i.e., creating art, making music, writing etc… However, trading is not one of them. The forward trend is hugely skewed in algo’s favor as well. Moore’s Law of exponentials clearly proves that computing power globally is growing at an unprecedented pace, and not surprisingly, so have powerful quantitative programs trading in the markets across every single asset class – from equities to currencies to sports betting.

Hold on tight, as this ride may get even wilder. Any good fundamentalist will argue that computers cannot cope with or understand complex global geopolitical and financial situations.  However the ability for computers to crunch, model, and forecast this data has greatly improved in just the last year alone, and continues to advance at an astonishing rate. That’s right, we are talking about a computer being able to interpret and understand global market “sentiment”.

During some of our research on this subject, we have been blown away by the sheer size and recent advances taking place in the computing world which will be impacting us all in one way or another. For example; recently bio-engineers at Stanford University developed a circuit modeled on the human brain. Sixteen “Neurocore” chips simulate one million neurons and billions of synaptic connections, claimed to be 9,000 times faster as well as more energy efficient than a typical PC. This year, Intel and Micron announced 3D XPoint, a non-volatile memory claimed to be up to 1,000 times faster, up to 1,000 times higher endurance and similar in density compared to NAND. Production was scheduled in 2016. The craziest concept to really understand here though, is that by the time you read this, these breakthroughs will already be OLD NEWS! That’s how fast this is moving.

We also now have freely available, open source AIs (artificial intelligence) – which any kid with an internet connection can access. Genetic algo building, machine learning, and neural networks are becoming common tools for clever people and organizations to use to solve a vast array of problems. Lastly we have D-wave quantum computers currently being sold out of Canada which are not even fully understood by their developers in terms of how they function – however the first commercial quantum computer is expected to be available before this year is out. These are expected to change our society as a whole (not just the financial markets). The race to quantum supremacy (validation of quantum computing) is in full force with a few other groups in the race (not just D-wave) and while excitement is high, the full scope of these machines’ abilities and how they will impact us still remains unclear. We only know for sure that they will have the ability to solve complex problems that even the most powerful supercomputers in existence now, cannot.

Naturally, some of the most brilliant minds will be (and already are) applying these advances in technology to the financial markets. Now, if this all sounds incredibly “power-nerd only” compatible type of stuff, keep in mind that that one does not require this degree of sophistication in order to create a successful algo (in fact some of the best algos employ the simplest of strategies). Further there is technology already developed where one can use simple interfaces to use the technology (negating the need to learn complex algorithms and programming languages). This lowers the barrier to entry in a huge way. There is no denying however that all of these tools (both simple and complex) are becoming more easily accessible than ever before in our history, and thus making them readily available to the average person, and also… the average trader!

In light of the growing trends, and the sheer exponential growth in computing power – we strongly believe that the future will leave very few manual traders behind who are not at least using SOME computerized tools in their arsenal. Whether that is simply analytical tools, statistical tools, or varying degrees of complex algos.

So if we had to pick the clear winner … in this day and age, we are going to side with algos. However keep in mind that as mentioned above, we feel that this shouldn’t be a strict black and white, line in the sand type of competition. Rather – more of a marriage; between thoughtful creative minds, collaborative teams, think tanks, and the proper usage and deployment of cutting edge technology. We strongly feel that this synergy is the true set of keys to success in the future of global financial markets.

Note: because of this, and in light of our ongoing research and careful analysis on the topic, we strive to keep our entire portfolio to be upwards of 80% algo based. While it will be mostly systematic, we ensure our programs include a significant and constant continual human adaptive overlay which we all highly value.

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