Pocketing Peanuts: Why High Speed Algorithmic Traders' Profits on Economic Trends Are Declining

Hedge fund and private equity returns are disappointing. Investment bankers, like the gold rush prospectors of the 1840s,  are taking their talents to Silicon Valley.

And high speed algorithmic traders, celebrated for applying technology and the knowledge it provides in the pursuit of higher profits are finding their initial advantages waning as everyone else pursues the same tactics.

What's a Master of the Universe to do?

Technology is proving to be the problem just as it was initially perceived to be the solution. The issue is that the democratization of data has given too many people access to the same secrets. And since most of them follow similar strategies, driven by similar software, hardware, backgrounds and perspectives, it should not be surprising that they are achieving similar outcomes, meaning that there is less for everyone. JL

Annabelle Ju reports in Bloomberg:

Although algorithmic traders respond swiftly and convincingly to macro news releases, the economic benefits of trading on announcement surprises are modest. There’s nobody left to exploit.
High-frequency traders treat the latest economic reports like predators stalking their prey, pouncing in tiny fractions of a second to buy or sell according to whether it was good news or bad.
For all the preparation and high technology, a new academic paper suggests they’re not minting money in the stock market.
Emory University researchers examined how much the fastest firms earn with two key financial products in the moments after major U.S. economic data comes out. In aggregate, algorithmic traders made about $24,000 per event with the SPDR S&P 500 ETF Trust and $75,000 with E-mini S&P 500 futures contracts, the academics found. That pales in comparison to the $100 million of total trading after such reports, according to the paper.
“They’re not able to make a lot of money from exploiting slow investors following macroeconomic news,” Clifton Green, an associate professor of finance at Emory and one of three authors of the paper, said in a phone interview. “Concerns that they’re exploiting slow investors may be overstated.”
High-frequency traders have been the target of critics who say they use the fastest systems to gain an advantage over other market participants. A subset of those firms aim to make money by being the first to react to the latest news. (Bloomberg LP, the parent company of this news organization, gives traders access to economic reports.)

Fast Reactions

Because of the substantial investments they’ve made in deploying the most advanced trading systems, they can react to fresh information within tiny slices of a second -- in times measured in millionths of a second or even billionths.
The researchers -- Green, Tarun Chordia and Badrinath Kottimukkalur of Emory University in Atlanta -- only examined an exchange-traded fund and futures contract tracking the Standard& Poor’s 500 Index. Traders can and do buy and sell other stocks and derivatives following economic releases. The paper didn’t examine those products.
The findings indicate profits from event-driven trading may not be substantial -- or at least not for any given economic report. “Although algorithmic traders respond swiftly and convincingly to macro news releases, we find the economic benefits of trading on announcement surprises are modest,” according to the paper.
Income from such trading has shrunk because there’s more competition, Green said. The study found that during the span of 2008 to 2013, the smallest annual earnings were generated in the most recent year.
“The idea is that there’s nobody left to exploit,” he said. “So, people willing to trade or trying to trade are both moving quickly in response to the news.”