The number of human traders employed in the financial markets is set to fall dramatically over the next ten years as banks and brokers become increasingly reliant on computer-based algorithms to run their trading operations. This is one of the early conclusion of the UK Government's Foresight panel, which was assembled to study the implications of high frequency trading on the economy.
The Foresight project team has worked with a panel of leading academics and industry participants to produce a working paper exploring the impact of computer trading on financial stability and market quality. While economic research provides no direct evidence that high frequency trading has increased volatility, the paper notes that self-reinforcing feedback loops in automated trading programs can lead to significant instability as undesired actions and outcomes are amplified.
The feedback loops can involve risk-management systems, and can be driven by changes in market volume or volatility, by market news, and by delays in distributing reference data. Today, notes the paper, over one third of United Kingdom equity trading volume is generated through high frequency automated computer trading while in the US this figure is closer to three-quarters.
This trend is expected to gather pace over the coming years, as advances in computing are seized upon and applied by competing trading houses.
"Just as real physical robots revolutionised manufacturing engineering, most notably in automobile production, in the latter years of the 20th Century, leading to major reductions in the number of employees required at car plants, so the early years of the 21st seem likely to be a period in which a similar revolution (involving software robot traders) occurs in the global financial markets," states the paper.
As a consequence, the number of front-line traders employed by major financial institutions is likely to fall, but there may be increased demand for developers of algorithms.
"While unlikely, it is not impossible that human traders will simply no longer be required at all in some market roles," notes Foresight. "The simple fact is that we humans are made from hardware that is just too bandwidth-limited, and too slow, to compete with coming waves of computer technology."
Hugh Cumberland, business development manager, Colt enterprise services, a company that provides technology to the likes of the London Stock Exchange said: "Recently, there have been many negative reports around the impact of high-frequency trading on capital markets. This report released today suggests there may be two sides to the argument. People have to understand that HFT is not automatically a bad thing. When all is said and done, more buys and sells must mean more liquidity, not less? Algorithmic trading benefits from price correction. This means that if it never corrects, you can never profit from the inefficiency. Therefore, a decreasing effect on volatility would seem to make perfect sense. As regulators continue to mull over the supposed disadvantages of algorithmic trading to the end investor, they may want to actually objectively establish if it is really such a bad thing?"
The working paper is being released as an expert, independent review of the emerging evidence base on computer trading, rather than representing Foresight's findings or conclusions on the issues addressed. Foresight's final report, which will be used to guide government policy, will be released in Autumn 2012.
Click here to read the paper