The Risk Of Speed

When it comes to automation, people tend to assume the robots will perform the same tasks as the humans they replace, just with fewer mistakes and fewer days off. While that is true, automation almost always means changing how the work gets done, in order to break it into discrete operations. Instead of a man at a workstation, doing a series of tasks, each task is done as a single event by a single robot. This simplifies the task of automation and reduces the cost of the automation by eliminating variables.

This atomization of the work not only makes the work process more efficient, it changes how the humans have to analyze it. Instead of focusing on the people, they must focus on the process. That’s always part of process improvement, but because the process changes and the variables change, new phenomenon turn up in the process. In statistics, they say quantity has a quality all its own. In automated systems, speed has a quality all its own. Those super fast, super accurate robots change the nature of the process.

Think of the game of table tennis. It is a pretty simple game, in terms of strategy. The players try to trick one another with various tactics like setting up a shot or putting spin on the ball so it is hard to return. Player A will use top spin to force Player B to change how he strikes the ball. At some point Player A will change, thus fooling Player B, who then hits the ball beyond the far edge of the table. Alternatively, one player will make the other player move side to side, increasing the chances of a physical error.

If you are coaching table tennis, it is all about training the human to play against the other human. Now, replace the players with robots. The first thing that changes is the players will not make physical errors. So, the side to side business no longer makes sense. The same is true of using ball spin to induce a physical error. The robots will strike the ball correctly each time. In other words, when you remove human error and human emotion from the game, the strategy of the game has to change as well.

It also means the game changes. For example, the team that makes the first robot player will build it to capitalize on human error. Soon, other teams will replace their humans with robots. At that point, everyone stops trying to exploit human error. Instead, they are trying to make faster robots. If their robots can exceed the physical limits of the other robots, then they win. Soon, there is an arms race between the robot builders to make the fastest robot, in terms of physical response, along with the faster processors.

If you stop and think about what this would look like, it sounds kind of cool at first. The first robots would be slow and stupid, but eventually they would pretty amazing. They would go from amusing to terrifying as the speed of the game would become incomprehensible to humans. The speed, agility and processing power of the machines would have the ball flying through the air near its maximum velocity of 900 miles per hour. The paddles would be made of special material, in order to prevent them from flying apart.

Automating the game of table tennis would first result in removing the strategy of the game that exploits human failure. This would be true of any system that is being automated. System analysis would also change as the speed of the machines would create new points of failure and new challenges, in terms of finding efficiency and a competitive edge. In other words, as the problem solving shifts from the human variable to the engineering issues, system analysis has to change accordingly.

Now, instead of robots playing table tennis, let’s think of something else. Currently, close to 90% of trades in the equities markets are done by robots, which are just computer programs attached to the financial system. These programs have access to financial data throughout the system, which is inputted into their systems and the output is the buy and sell decisions. Teams of smart people called “quants” spend endless hours fine-tuning their programs to make them faster and more efficient at trading equities.

If you read the book The Money Game, which was written in the 1960’s, it presciently predicted the rise of the machines in the financial markets. What was clear to smart people at the dawn of the robot age, but not clear to most people, is the old systems regulating and controlling markets would not hold up to automation. It took the Black Monday crash of 1987 for everyone to realize that the controls had to change in order to accommodate the new robot players in the financial system.

In the 2000’s, the rise of high speed trading algorithms and large scale trading models eventually broke the system again. The emergence of the so-called “flash-crash” was entirely due to speed. While the first phase of automation removed the normal human checks on trading, resulting in runaway selling, the next phase of automation allowed for bad human decisions, like errors in trading algorithms, to be implemented so quickly, the systems could not respond. The result was erroneous sell-offs.

That brings us to the current market volatility. The decline itself is getting all of the attention, mostly for marketing and political reasons. The dullards in the media know how to sell gloom and they like blaming bad news on Trump. Historically, this bear market is not important. Whether it is called a correction or a bear market, the numbers are not all that significant. We’ve seen much worse. No one is jumping from their office windows and the public is not banging the sell button on the investment account.

What’s unique about this market is the weirdness. There is sustained volatility, but also a sustained decline, that does not appear to correlate to factors in the economy or in the financial system. The tiniest bit of news can cause wild swings. Apple announced what everyone should have known by now, that their toys are not selling as well as in the past, and the market takes a big tumble. Apple shares dropped 10% in minutes. Of course, this ripples to the rest of the market in seconds as well.

What could be happening is the next phase of automation. The speed and complexity of the algorithms are no longer comprehensible by the humans involved in the system. Like our table tennis playing robots, a level of speed and complexity passes the event horizon of humans to comprehend. Watching the robots play table tennis would be like watching a whirl of stars, beautiful, but impossible for the mind to fathom. Similarly, the new market dynamics may be reaching the limits of human regulators to fathom.

This is not to imply that the robot traders have become aware and are now taking control of the system from humans. That would be interesting, but the robots are still relatively dumb. Instead, they have reached levels of efficiency and speed that exceeds our ability to model properly. The result is the wild volatility and the seemingly irrational behavior of the markets. Put another way, this is the age of basic ideas implemented so fast and with such efficiency, they become irrational to their human creators.

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Nunnya Bidnez, jr.
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Nunnya Bidnez, jr.

The only way to win is to not play the game.

WOPR

Hoagie
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Hoagie

That’s not a “win”. That’s not even an “also ran”, it’s a draw at best. Without a participation trophy.

Member

It’s the only way not to lose.

BFYTW
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BFYTW

Or maybe the Austrians were/are right? Before we start writing the next Terminator sequel, think about that for a second.

Shrugger
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Shrugger

The automation you describe reminds me of what happened to the geeky battle bots originally birthed at MIT, which went on to become series of televised games. The first bots fought with weapons modeled after what humans use in hand to hand combat. They evolved into non-human weapons and strategies that test the limits of electric motors, gears, chains, belts, metallurgy, etc.

Based Millennial
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Based Millennial

What you call “robots” in trading are actually artificial intelligence algorithms called “machine learning” that train on past data in order to predict future data. Thus, past performances of data on oil stocks are trained on in order to predict what a future stock price of oil would be based on a given trend. A new technology called “deep learning” allows even more types of data to be used to train on the stock data. So now, along with past stock prices, you can train on the text from news sites. Deep learning has gotten sophisticated enough to recognize things… Read more »

DLS
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DLS

As Zman points out though, the computers are fast but dumb. In my masters level statistics course, I tried to develop a correlation between past data and future performance to predict stock movements. No matter how many variables or data points I added, I could never get a correlation coefficient above .5. Technical models are worthless because stocks move on anticipation, not past data. The only benefit computers provide is the speed of trades in the split second after news is released. That is why wall street firms lease computers from the NYSE. It gives them a fraction of a… Read more »

BadThinker
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BadThinker

All of these modeling tools are far too certain in their predictions. Machine and Deep Learning is very useful for modeling processes where the rules are well defined but the search spaces are wide, and there are very few variables (Chess, Go, etc). The robots trading the market are just doing what human traders have done for years. They make crazy predictions and they get lucky once in awhile. And they take advantage of timing arbitrage to get in ahead of another robot. At the bottom, it’s all gambling. I, for one, would like to see a few laws passed… Read more »

Alzaebo
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Alzaebo

“Company ownership used to mean the actual owner was responsible for his company, took care of his workforce, and provided social capital to the place of his business.”

That’s the money quote, right there. This ain’t yer granpappy’s capitalism.

ChrisZ
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ChrisZ

Zman, this was a great column, illuminating a difficult concept. Was it something in the works for a while, or the result of a “spontaneous” insight?

The ping pong analogy cleverly clarified the larger issues of automation. I’m going to share this with my son who will be starting an engineering program in the fall. Thanks.

Yves Vannes
Member

“That would be interesting, but the robots are still relatively dumb. Instead, they have reached levels of efficiency and speed that exceeds our ability to model properly. The result is the wild volatility and the seemingly irrational behavior of the markets.” This is an example of a problem by a philosopher named Hubert Dreyfus (died a few years ago). He published a book titled “Why Computers Can’t Think” followed up some years later by “Why Computers Still Can’t Think”. The AI crowd called him every name under the sun for a decade or two until they came to realize he… Read more »

DeBeers Diamonds
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DeBeers Diamonds

Check this out here, a blast from four years ago at the start of the Gamergate. The narrative in favor of AI censorship wrapped in female victimhood was already there, long before the term “Alt-Right” had come into public discussion.

https://www.thedailybeast.com/will-the-internet-ever-be-safe-for-women

Can they make a female AI able to understand their illogical feelings?

TomA
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TomA

What you are describing is hypersensitivity, which is detrimental to robustness. In natural evolution, this characteristic is frequently eliminated from the population because it does not enhance reproduction. Similarly, if in our modern age of accelerating technology (and it’s side-effects of hardship extinction and dependence addiction) people choose to live in the moment rather than make babies, then organic robustness will decline until the species becomes vulnerable to a mass extinction event. Oddly, a financial crash that triggers a severe depression is actually a cure for hardship extinction.

Drake
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Drake

It treat the general financial news just like the drivel that is the normal news – noise to fill the airwaves between commercials. I invest in 3 ways. 1. My company 401k has fairly limited choices of funds. I spread my savings around there as best I can. 2. Most of my after-tax savings goes into other mutual funds in sectors I think are fairly stable. 3. Once in a while I buy actual stock in a company I think will grow – and hang on to it for a while (usually years). The day-to-day stock news seems like complete… Read more »

JEB
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JEB

I don’t know what impact this has on your main thesis, but it definitely isn’t true that “The robots will strike the ball correctly each time.” Robots, just like humans, have physical limits, and if you push them to their limits they will start making errors. And humans can in fact play without error, provided they are playing well below their own limits. (Imagine a slow friendly game between an amateur and a world champion. The champion will probably not make any mistakes). So strategy will always have a place in the game, whether the players are biological or mechanical.

Member

No, the issue is pretty simple. Somebody wrote some code that says “if the Fed raises rates, sell”. Could be as simple as a yes/no switch somebody throws that is Fed/good, Fed/bad. The robots start buying or selling accordingly. I’ve said for years that in the absence of ZIRP the Dow would be 2/3 or 1/2 it’s present value. Low rates were maintained to prop up Obama. They would have been maintained to prop up First Woman President. No reason for that now. Plus the Fed needs someplace to go when the next recession inevitably arrives. Like the last couple… Read more »

Member

While the basic argument is still good, I’d bet the maximum velocity of a ping pong ball is more like 90 mph, not 900, as that would exceed the speed of sound and result in the ball being crushed with every blow.

Member

Read It and weep! (I love engineers!)

https://www.thoughtco.com/ping-pong-ball-maximum-speed-3974874

And that’s before the ball gets altered to maximize velocity by increasing the elasticity of the collisions.

james wilson
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james wilson

Interesting. 916 mph. Never dowt the Zman. When they take my guns I’ll carry my fully automatic pong pistol instead.

Member

Sure when fired by some cannon, and it says that would blast right through a paddle. Are they going to start using titanium? Top slam speed of 70 mph is more realistic.

Member

Yes, yes they would. The physics is still conservation of momentum/energy. Also, programming the robot to increase contact time (follow through) which increases impulse and therefore momentum. Don’t believe the technology would advance to meet the need? Just look at modern football helmet tech. The only limiting factor is monetary. What is the financial benefit of hyper fast ping pong? Or, missile defense, or tank armor, since it’s the same set of physics principles in play. Tanks use ablative armor to deflect projectiles (protect the paddle, so to speak). Missile defense is basically trying to hit the ball (missile) with… Read more »

Citizen of a Silly Country
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Citizen of a Silly Country

True, but the algorithms are written by humans to reflect a certain strategy so they’re just executing what a person would have done more quickly. There’s not a ton of money in self-thinking AI algorithms. The biggest amount of money in a single strategy is index funds, particularly the S&P 500. It’s an algorithm. Buy or sell stocks to track as closely as possible the S&P 500 index. And, yes, index investing is a “quant” strategy. Any strategy based on a set of rules – usually developed in academia or certainly by practitioners who have academic training – and implemented… Read more »

Dutch
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Dutch

Keep in mind the financial “news” is about coming up with reasons to explain today’s market fluctuations. There is a psychological overlay to market pricing, and taking advantage of the “madness of the crowds” is how George Soros got very rich. Investing is about taking specific positions and then sizing your bet properly. You can do this strategically (long term) and tactically (short term). Long term investing weighs the changing value of the investment choice over time, and a successful choice involves owning something in which the intrinsic value of ownership rises over time. Short term investing involves getting the… Read more »

DeBeers Diamonds
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DeBeers Diamonds

Off topic: Pope Tim surprised to learn that the Chinese market is being steered away from roundeye phones in favor of Chinese state-owned company produced phones.

https://www.marketwatch.com/story/apple-lives-up-to-wall-streets-fears-with-massive-revenue-shortfall-2019-01-02

On the plus side, the cost of nationalization just went down.

Member

The Chinese are thieves. I still can’t believe we shipped all those jobs to China just so they could steal the technology and build “spy-ready” phones for their slave population.

Madness.

Dutch
Guest
Dutch

“Spy-ready” for the ones they send over to us as well, from what I hear.

Member

Yep, DoD doesn’t allow Lenovo laptops for example.

Clayton Barnett
Guest

Very thought provoking, ZMan… but I had to smile at the robots/ping pong analogy as that takes place in the Prologue of one of my recent novels.

https://tinyurl.com/yb94jovv

Edgar Guest Memorial Poetry Section
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Edgar Guest Memorial Poetry Section

The real underlying problem in all this — not that this gonna go away, or that the world will obey my whims — is that the underlying premise for value in an over-financialized universe is just ever more elaborate forms of arbitrage, or what we used to call skimming. Usury is slavery, and at this advanced level, arbitrage is just more slavery. These people don’t create value, they just get rich skimming a wee bit off of every transaction, for zillions of transactions. It’s just highly-organized mass theft, and it enslaves millions as a result. Value needs to be predicated… Read more »

Dutch
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Dutch

Going back to Nunya’s entry at the very top, only buy what you want to own. If you don’t want to own it, or not pay the price being asked, simply pass. It has become all about trading ‘em, not owning ‘em. Wall Street gets paid when you trade ‘em, but not when you buy and keep. Don’t fall for their game, they want to make it a horse race and have you switch horses. Instead, treat it like real estate; Buy low, collect the rents, build equity, and wait. Boring as all hell, but very profitable in the long… Read more »

BadThinker
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BadThinker

Most modern corporate executives are skimmers, not stewards. Ownership should come with responsibility. Limited liability and governmental blessing of incorporation have helped lead to this mess.

Dutch
Guest
Dutch

The typical executive contract gives big bonuses (in stock or stock options) for a substantially higher stock price over time. They then “short-time” the decision making in the stewardship of the company, and base it all on what it will do to the stock price in the short run. And there you go.

Larkin Lover
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Larkin Lover

Two things: 1) re AI and humanly incomprehensible, the new chess program Alphazero recently dethroned the formerly strongest Stockfish, which the world champion was only able to draw in a minority of games. Alphazero was designed from a stochastic program invented to play the Chinese game of Go, which is in fact more intuitive than chess, and AI had been unable to defeat the strongest Go masters until Alphazero, which recently defeated the strongest Go player, a historically strong player. It broke his spirit and he cried! The technology was adapted to chess, and Alphazero learned by playing fifty games… Read more »

Dutch
Guest
Dutch

Use a semi-log chart and you will have your answer. You are looking a compounding over a massive length of time in arithmetic form. You need to look at returns over time on dollars invested, and held, in a dynamic arrangement, and that is logarithmic, not arithmetic.

Member

Consider the possibility that this apparent irrationality and volatility has been happening all along, since the beginning of the stock market, but, the ability to report the second-by-second actions of the market was lacking.

Perhaps all the crazy price action is simply the result of faster methods of reporting the action.

Matrix
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Matrix
A.B. Prosper
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A.B. Prosper

Imagine a society where 90% of everything is done by robots

Who buys all the production?

The answer is the State

Fundamentally though societies will have to be either for the benefit of the elite and their machines assuming they don’t exterminate the rest of us or humanity which suggests we’ll need a Butlerian Jihad sooner than later.

Rod1963
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Rod1963

OT:

There is a transcript about from Tucker Carlson’s monologue on Breitbart about families, markets and our leaders. It’s so alt-right it’s scary and is one of the best I have ever come across in the last 30 years.

https://www.breitbart.com/video/2019/01/03/carlson-romneys-trump-attack-indicative-of-a-ruling-class-who-feel-no-long-term-obligation-to-the-people-they-rule/

This is the sort of article that one can pass around to prospective people who are leaning alt-right.

Member

This pattern has held for a long time. Trading technology advances beyond the ability of the regulatory structure to manage it. Everyone knows this is happening. That is always the effective result (and sometimes the explicit stated intention) of the technical advance. Due to regulatory capture the problem generally goes unaddressed until the inevitable crash. Then a new regulatory structure is instituted addressing the causes of the latest crash, and the pattern repeats. If anyone is around to pick up the pieces this time, we’ll get a transaction tax and a capital gains tax seriously penalizing short term holdings. Maybe… Read more »

A.B. Prosper
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A.B. Prosper

This is one of the biggest weaknesses of the Right. They don’t have a clue as to how dangerous our tech can be. Given any chance corporations will enslave you faster than the Government and the only check in the State. Right wing views? You don’t get to buy anything. Deplatform you from life or just chip you and use as a machine tool ala Continuum The only way to prevent is is a regime that controls how tech is used. I think elements of the Right think the collapse will be safer and will manage to keep tech in… Read more »

dad29
Guest

Babylon redux, baby!!

Maus
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Maus

If extreme volatility is once again rearing its head, the antidote for most average-joe investors is Harry Browne’s Permanent Portfolio. He advocated a mix of 25% total stock market index fund; 25% long U.S. treasury bonds; 25% gold; and 25% cash or cash equivalents. With ETFs, it is easy to assemble such a portfolio and rebalance it when any one of the four asset classes is + or – 10%. Each asset is held to perform in one of four prevailing economic conditions: stocks for growth/prosperity; gold for inflation; bonds for recession; and cash for deflation. It rarely hits home… Read more »

Joshinca
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Joshinca

Yeah, or maybe it’s just a function of the fed unwinding QE.

Unknownsailor
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Unknownsailor

Carl over at Market-Ticker.org has talked about HFT. He noted as well that the speed of the huge trading houses could lead to a human investor loosing everything in the blink of an eye due to how fast trades can be done by the algorithms. HFTs have been playing games for a long time, and need to be hemmed up. He has been saying for a while that there needs to be at 2 second minimum dwell time when a position is posted to when it is removed, just to give a human trader a chance to react to it.… Read more »