THE combined forces of speed and technology are turning the stock market into a different animal from the days of our fathers and mothers with small retail players being the casualties of the sweeping changes, particularly in the West. This is the dark side of technology which cannot be ignored but which must be managed by regulators.
This was the message by Edgar Perez during an interview some weeks ago while he was passing through Kuala Lumpur after a 10-day trip to Indonesia and on his way to South Korea to conduct a Speed Traders Workshop.
At only 30-something, Perez has become adept at this subject. Much of it has to do with his interest and being at the right place at the right time with the right qualifications. Perez, author of The Speed Traders, An Insiders Look at the New High-Frequency Trading Phenomenon That is Transforming the Investing World, was born in an era when computers and technology have become pretty much part of his everyday life.
He was on an Asian circuit, having been in Indonesia for about 10 days to do some interviews for his upcoming book.
I was talking to people just as you are now talking to me. I find all these travelling very exciting, he says over a lunch at the Stars cafeteria in Petaling Jaya.
Perez is Peruvian. His first degree is in information systems. He was so interested in banking and finance that he did a masters on it in Peru.
I found that I was moving away from technology and into banking. While I was interested in both, banking and finance seem to be winning over.
When the opportunity to work in New York in an e-commerce company selling gifts and flowers in 2000 came, he took it. His keen and agile mind led him to pick up another qualification, this time an MBA in the famed Columbia University where he majored in business and finance.
I met many interesting people from different backgrounds and that was one of the things I got from Columbia, besides my MBA, he quips.
He later landed a consulting position in McKinsey & Company as a consultant where most of his clients were from financial institutions.
He later joined the Citigroup as vice-president of training and education.
I was also looking at the evolution of trading and how technology became so intertwined with it. That led me to organising conferences on high-frequency trading around the world, he recalls.
His first event was in March 2010 in New York. It was also the first time such a conference was held.
Opportunities in chaos
2008 was very difficult for everybody and many lost money. However, there was a group of people who were making money. At Citadel hedge funds, its flagship fund was making money. With only 50 people, this group was generating US$1bil in 2008 in profits. All the rest of the funds were bleeding. People began to ask, what is going on' And what is the group doing' he wonders.
Perez says the financial research TABB Group reported that US$20bil was generated by high-frequency traders that year. One year later, Russian Sergey Aleynikov, 41, a former Goldman Sachs programmer, was detained in Newark Airport, New Jersey.
He was trying to siphon off a computer code which he had earlier downloaded, allowing Goldman to profit from high-frequency trading. Aleynikov was planning to join another company where he could use that code.
He was getting US$400,000 a year from Goldman and he would get three times that with the new company, says Perez.
The case generated a lot of interest because the computer code or software was used by Goldman to do sophisticated, high-speed, high-volume stock and commodities trades which earned the company many millions of dollars in profits each year.
(The court reversed the conviction of Aleynikov, who was sentenced to eight years. He was convicted in 2010 of theft of trade secrets under the Economic Espionage Act.)
High-frequency trading is computer executed trading. Humans, explains Perez, are slow by comparison, when identifying the different markets and location and products. It is a field for technology, which is fluid, fast and is able to complete a deal in miliseconds.
Let us assume you are interested to sell 500 IBM shares. You are only interested to get your cash immediately. However, when you sell IBM, that is not a unique entity. It has a component of exchange-traded funds, and is a component of Standard & Poors. There are also derivatives which rely on IBM stocks.
If I sell IBM, there will be pressure on price, which affects the options and derivatives markets. All these changes take time to compute. Computer can detech the impact of the sale and is able to calculate the next price of the derivatives and options compared with the current price. This happens even before the price is adjusted.
It is computers that accelerate the change, be it good or bad. Computers are rationale but people are emotional. Out of emotions, man may sell a big order, but it is computers that accelerate the decline, says Perez.
The impact of this is tremendous on regulators.
Regulators are struggling to regulate the market but they are facing a huge challenge in this new and changing financial system, says Perez. This was clearly seen in the flash crash of May 2010 when the US stock market lost nearly 1,000 points in 20 minutes before it recovered.
There was no circuit breakers then. It took the regulators nearly five months to analyse the data and generate a solution, he recalls.
Living with technology
Perez also spoke about BATS Global Markets Inc, the exchange where a software glitch in March dashed its attempted public offering. There is always the possibility of a computer malfunction. But that does not mean you do away with technology in the stock market. Likewise, car accidents happen. So do you stop driving'
So I expect regulators to be proactive and to take measures. High-frequency trading can only happen with technology, which will continue to be a part of trading, no matter what we do or say, he says.
A decade from today, high-frequency trading will be considered slow because something else has taken over. The speed should not be the cause for worry. What is important are regulations and having a real-time view of the markets.
Perez says over 60% of trading in the United States use high-speed trading today; in Europe it is more than 50% and 40% in Japan. So computers will continue to replace humans.
Perez says he drew his inspiration from all that was happening around him in the trading and financial world and was inspired to put it into a book.
What is the future' We will continue to evolve but there will need to be a new regulatory framework.
If I were a trader, I will be happy. There are many benefits of high-frequency trading. It provides high liquidity. Exchanges today are trying to increase revenue.
They do with trading commission. Another way is co-location where computers are located near or next to exchanges to enable them to leverage on speed. A third source of revenue is data feed where exchanges are mandated to publish a price, he says.
All these are exciting for him and he is eager to find the next trend. There are so many hedge funds in the United States and the next trend may not be far from emerging but his next book is about Indonesia, a nation of some 240 million people.
On his new book on Indonesia, he says the archipelago will be the top five economies in 50 years and his book, he says, will be ready in three months.
BORN: Feb 7, 1974
HIGHEST QUALIFICATION: Master in Business Administration(MBA), Columbia University
CAREER: Author, global entrepr eneur and consultant, go-getter
● The Chinese version of my book, The Speed Traders, is to be published by China Fina ncial Publishing House, the exclusive professional financial publishing house affiliated with China, joining luminaries such as Nobel laureates Joseph E.Stiglitz and Robert Mundell
● Presented at the worlds most prestigious educational institutions , including Harvard University, Massachusetts Institute of Technology, Columbia Business School, and New York University
FAVOURITE FOOD: Ceviche, pierogi, beondegi
FAVOURITE PLACE: Machu Picchu, Petronas Twin Towers, Fontana di Trevi
HOBBIES: Hustle and salsa dancing, movies
VALUES: Family-oriented, strong work ethic, global focus
INSPIRATION: Mother Theresa, Henry Kravis, Bill Gates