goldman sachs algo trade gets them trouble

The Paulson case is going to open the can of worms about algo trading. Goldman Sachs is the leader in the devious end of this trading. This is an extract from Wickipedia...

Issues and developments

Algorithmic trading has been shown to substantially improve market liquidity[25] among other benefits. However, improvements in productivity brought by algorithmic trading have been opposed by human brokers and traders facing stiff competition from computers.

Some have claimed that the models used in algorithmic trading are known to have limitations, and the programs may break down under stress. However model limitations are not always known, so it is common for a major part of the effort in developing a system to be fail safes and sanity checks.

The downside with these systems is their black box-ness, Mr. Williams said. Traders have intuitive senses of how the world works. But with these systems you pour in a bunch of numbers, and something comes out the other end, and its not always intuitive or clear why the black box latched onto certain data or relationships.[23]

Regulators in both the US and UK have long watched algo trading, since its alleged role in Black Monday where automated trading was perceived to have accelerated the downturn.

The Financial Services Authority has been keeping a watchful eye on the development of black box trading. In its annual report the regulator remarked on the great benefits of efficiency that new technology is bringing to the market. But it also pointed out that greater reliance on sophisticated technology and modelling brings with it a greater risk that systems failure can result in business interruption.[26]

UK Treasury minister Lord Myners has warned that companies could become the "playthings" of speculators because of automatic high-frequency trading (HFT). Lord Myners said the process risked destroying the relationship between an investor and a company.[27]

Other issues include the technical problem of latency or the delay in getting quotes to traders,[28] security and front running, and the possibility of a complete system breakdown leading to a market crash.[29]

Although some systems such as those being developed by Goldman Sachs are expensively developed, the market also includes many players whose total resource applied to the development and maintenance of the system is between one and three people.

The cost of developing and maintaining algorithms is still relatively high, especially for new entrants, as the need for stability, bandwidth and speed is even higher than for regular order execution. Firms which have not developed their own algorithmic trading have had to buy competing firms.

"Goldman spends tens of millions of dollars on this stuff. They have more people working in their technology area than people on the trading desk...The nature of the markets has changed dramatically."[30]