Financial markets are evolving rapidly in the wake of converging forces such as globalisation, competition, and geopolitical and demographic shifts. The pace of technological change has also fuelled many new products and services, which significantly alter the dynamics of financial trading.
Digital innovations, such as high frequency computer trading and algorithmic trading have grown in recent years, with computer trading now representing over 30% of equity trading in the UK, and algorithmic trading expected to grow at an annual rate of 11.23% over the forecast period (2021-2026).
The development and application of new technology, coupled with the increasing complexity of financial and trading markets, will have a huge impact on their future. Let’s explore this more closely:
The impact of technological development
The current move to increased automation on the trading floors of exchanges, banks and fund management companies marks a natural and inevitable progression, following on from similar shifts to automated production, such as the one that manufacturing engineering underwent during the 1980s and 1990s.
The interaction of affordable computer power, statistically advanced trading strategies and quick, automated execution, means that it has become very normal for market participants to complete transactions within a few seconds. Computers facilitate market activities such as trade, liquidity provision, information dissemination, and regulatory monitoring. They can also process and analyse historical data, allowing participants to observe numerous data streams and carry out trades automatically.
Despite ever-increasing computer power, these machines remain far from fully intelligent. From an economic point of view, they provide a clear example of ‘bounded rationality’ – limited by time, their thinking capacity, and the information available. As such, it is vital that policy makers are informed, and make regulatory decisions that address current market concerns, while preserving future benefits that computer trading may bring.
An algorithmic trading market
Algorithmic trading (also known as algo-trading or black-box trading), is a method of executing trade orders with the help of an automated set of instructions. Algorithms are pre-programmed to search for inefficiencies that exist in the market, as per the criteria defined by the participant.
Algorithmic strategies have a natural life cycle, and a given strategy’s performance decreases with time as it becomes more common and reduces the inefficiencies that allowed it to exist initially. New algorithms are continually being created in response to market conditions, while the increase of successful strategies change the market. This dynamic process allows algorithms, markets, and regulations to evolve in competition with one another.
The need for rapid and effective trade execution, more market surveillance, and reduced costs, are likely to accelerate the need for the algorithmic trading market. Financial institutions, such as banks and brokerage houses, already frequently turn to algorithms to minimize the expense of bulk trading.
The future of computer trading
Advances in the sophistication of automated trading technology are expected to continue for at least the next ten years. Today’s financial markets involve human traders interacting with large numbers of ‘robot’ trading systems, but future machines will be able to learn and adapt with little human involvement in their design.
For international growth and prosperity in financial markets, however, it is important that future policies and market regulation preserve the benefits of computer trading, whilst also working to reduce the possibility of instabilities and periodic illiquidity that can occur. It is important that we teach the present and future generation of economic decision-makers how to capitalise on the opportunities of computer trading, whilst also systematically assessing its risks.
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