Shadow Liquidity

On any given day, nearly 70% of all trades on the major stock exchanges are done by the bots (see below for more on what a bot is) owned by the high frequency traders at the top investment banks and boutique trading firms. An interesting side effect of all these bots, is that their activity serves as a form of critical shadow liquidity for the stock market. Venture capitalist Paul Kedrosky has some insight into what this means (which was the driver for failure on Thursday):

For the first time we have large providers of this shadow liquidity, algorithms and high-frequency sorts, that individually account for large percentages of daily trading activity, and, at the same time, that can be turned off with a switch, or at an algorithmic whim. As a result, in market crises, when liquidity was always hardest to find, it now doesn't just become hard to find, it disappears altogether, like water rushing out of sight via a trapdoor to hell. Old-style market-makers are standing aside as panicky orders pour in, and they look straight at shadow liquidity providers and say, "No thanks. You battle bots take it". And, they don't.

What is a bot? It's simply software that automatically gathers information and makes simple decisions.  It does this very quickly, without pause, day in and day out.  You can run thousands of them on a standard PC (depending on their complexity).  Larger operators (bot herders) can run hundreds of thousands to millions of them simultaneously.   Firms or individuals that have many, many bots are called bot herders.

What do bots do? Bots do everything from trading stocks (to generate pennies of profit per trade) to scanning credit card purchasing records for fraudulent activity to approving you for a mortgage loan to generating e-mail spam (or pinging your home network's firewall for weaknesses to exploit).  They are everywhere (and a big reason that a small group of global financiers can manipulate the global economy).

Some deep thinking on the future of bots. Daniel Suarez has a great presentation on this topic at the Long Now Foundation.

NOTE: In Daniel's book of near term fiction called Daemon (soon to be a movie), decentralized bots collectively known as the Daemon were used to automate a foco for a revolution against the corrupt status quo.  During the early phases, the foco bots of the Daemon engineered the slaughter of everyone operating competitive bot systems (aka: any system it wasn't able to gain control of), from spammers to high frequency traders.

From Global Guerrillas