Frank Thoughts: The Impact of Computerization
Dave Canal
March 11, 2021

If you follow financial news you are undoubtedly aware of the story about millennial stock traders using a computer network to challenge a 12 billion hedge fund. They impacted a stock appropriately named GameStop. Millions of them “colluded” in buying this heavily shorted stock, creating a short squeeze. Their effort drove the stock up 1,600% in a couple of weeks! “Pools” of organized speculators did this 100 years ago. It was then made illegal. But with computerization, it is so easy to do.

When Joseph Kennedy and Jessie Livermore did it, they were called financiers. Today they would be called hedge fund managers. Jim Simon of Renaissance Technologies and Ken Griffin of Citadel are examples. Last year Citadel paid brokerage firm Robin Hood close to $700 million to see their order flow. In boxing, it would be as though you paid your opponent’s manager to learn their fight plan. If you thought Robin Hood was just a children’s story, the media coverage of the new Robin Hood attempted to change that impression. It became a moralistic story with strong class overtones.

In the new version, “Little John” doesn’t live in Sherwood Forest. Instead, he rents a house in Massachusetts and has an office in the basement, which is typical of a 34-year-old millennial.  Robin Hood – this time - is a commission “free” brokerage firm the “Merry Band” trades through. It is a dramatic example of computerization’s impact on the stock market and its lack of relevance to investing. It is about perceived “free” trades … and as such encourages instant computerized betting.

This epochal change in investing occurred in 2006 when the N.Y.S.E., formally a nonprofit, became a for-profit organization.  Two previously unrelated activities – technology and investments – thus became joined. The advantage went to technology professionals. With no knowledge of investing, you could become very rich. Investment professionals cannot become rich in technology knowing nothing about technology. For the past 10-12 years technology has parasitically been living off the body of its host, the investment business.  Technology sophistication is not investment knowledge.   

Yet speed of stock execution, not investment skill, became the major factor in making money and was abetted by a for-profit exchange and dark pools. High frequency trading thus became the dominant force as it skimmed money from investor’s trades, peaking at 60% of trading volume. This resulted in close to totally obliterating price discovery, the very purpose of an exchange. Frustrated by lack of superior active management, investors then flocked to passive funds creating a negative feedback loop for active management. One that is just starting to be broken by even higher computer speed.

To give one a perspective, consider that it takes an individual 300-400 milliseconds to blink an eye. When a trade is done by a high frequency trading firm it now takes just 10 milliseconds. Had I said years ago, the best performance record would be held by an M.I.T. astrophysicist professor who holds a stock less than a second, you would have thought I was crazy. But last year Jim Simon’s main hedge fund at Renaissance Technologies (there are three) was down 30%. The S&P 500 was up 18%, resulting in a 48% differential! But shed no tears; he just retired with an estimated net worth of $25 billion!

This transition in the stock market has been the same as the change in our economy. Both evolving as the former industrial economy gave way to a knowledge-based economy giving math and technology a dominant role. The failure last year of Renaissance Technologies fund – down 30% - suggests Einstein’s immutable law that nothing can go faster than the speed of light may have been reached.

-Francis Patrick Boland

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