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Save the (Trading) Dinosaurs

MACRO VIEWSave the (Trading) Dinosaurs

By Mark Cudmore via Bloomberg

Markets would function far more smoothly and efficiently if the financial ecosystem supported a decent population of experienced human traders.
Thanks to algorithmic trading and regulation, flash crashes are arriving with increasing frequency. U.S. Treasuries, U.S. equities, the kiwi, the rand and now sterling have suffered from algo-centered meltdowns during the past two years.
Computer programs can’t understand when a market is broken. They can’t be programmed to fade random excessive moves because then they wouldn’t have an adequate fail-safe.

Regulation has significantly restricted “speculative” trading. This includes market makers providing much-needed liquidity in extreme circumstances through “speculatively” fading moves that look “wrong;” i.e. providing a gut-check during moments of panic.

If Friday’s sterling debacle had happened a decade ago, there would have been numerous experienced traders — aka dinosaurs — in FX trading rooms across Asia refusing to sell cable below 1.2200 on no news. Today, most of them have been killed off, while those that remain have seen their natural habitat severely restricted or encroached upon.

There’s now broad consensus that diversity in the workplace provides numerous positives. So why are regulators and banks combining to eradicate diversity on the trading floor by turning human traders into very similarly programmed algos?

There’s a need for experienced staff in that environment. Younger employees may fade moves they think are excessive but they have no context for their decisions. For example, the yen trader who started in the early 2000s may view a drop of a few big figures in USD/JPY as very rare — until they’re made aware of standard price-action in the 1990s.

Much like human civilization, markets are evolving to become more sophisticated, but multiplying the tail risks at the same time.

While computers and rule books are very good for removing emotions (and undesirable motivations) from decision making, they are only as good as their programming. Sometimes there’s a real need for an experienced, non-rule-based brain to intervene.

Like when building up the population of any endangered species, we can start by breeding in highly supervised captivity, but it’s important for the financial planet’s ecology that traders are eventually released back into the speculative wilderness.

Mark Cudmore is a former FX trader. The observations he makes are his own and are not intended as investment advice.

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