Game theory and option trading
With reputation at stake, the pressure on exchanges and HFTs has been mounting. Commodities and Futures Trading Commission, suggested that exchanges and regulators should consider requiring some market-making obligations from HFTs.
Some conforming exchanges are already under legal scrutiny. Several class action lawsuits are currently underway filed by private plaintiffs against HFT firms as well as against stock and commodities exchanges De Simone et al. Regulators have also stepped up their scrutiny of HFT practices.
Co-location services are primarily used by HFTs. The firm had been accused of using high frequency algorithms for price manipulation in its favor. It is important to note that current SEC regulations do not prevent exchanges from offering co-location and direct data feed services. Reg NMS, however, prohibits exchanges from independently transmitting their own data to anyone sooner than they transmit it to a data processor for inclusion in the consolidated tape.
This may give HFTs a legal argument that market information based on co-location and direct data feeds is public information. However, various forms of market manipulation by HFTs and other forms of collusion with exchanges still remain under legal scrutiny by several regulatory bodies.
However, these rules are largely intended to minimize the impact of systems failure on securities markets. At this time, it appears that the SEC does not intend to enact separate laws to address the improprieties involving HFT. The SEC intends to conduct a holistic review of problems in broader securities markets and, sometime next year, it hopes to introduce rules intended to protect investors from predatory trading practices VerHage and Gasparino As Dick asserted, it is not trading at high speeds but rather trading with special relationships between HFTs and exchanges that poses a threat to retail investors.
Lewis chronicled the evolution of IEX, which has devised a system that does not grant special access to any trader. IEX is able to route orders to multiple exchanges simultaneously in order to avoid front-running in a fragmented marketplace. IEX was established by a group of people led by Brad Katsuyama, who, while working with the equities trading group at Royal Bank of Canada, was concerned that a large number of his orders went unfilled at posted prices.
His team discovered how some HFTs were using their high-speed infrastructure and privileged access to exchanges to front-run client orders.
For orders routed through IEX, HFTs can still trade at high speeds and anticipate price movements, but they are unable to glean order flows before other traders. Nor are they able to glean information from quotes at one exchange a few microseconds before that quote appears on another exchange.
Rather than allowing HFTs to dictate the terms of the arrangements, the exchange moves first in denying them preferred access. This changes the outcome of the dynamic game. Reputation can prove potent in trust-based institutions and financial markets.
Over the long term, other exchanges may need to emulate the non-conforming with HFTs attitude adopted by IEX or lose business. Table 2 demonstrates this long-run outcome in the yellow shaded box. The current dysfunction in financial markets should not affect financial planning for most individual client situations. However, high net worth and institutional clients could lose much to rents extracted by HFTs if they are not vigilant.
The following guidelines can assist financial planners in preserving the wealth of their clients: Even so, small orders should only be placed using a limit order at the posted bid and ask quotes. Most share orders do get filled at posted quotes. Even as HFTs scour various exchanges to detect large order flows, they do end up filling some small orders as they stay ahead of the queue. Clients interested in small company stocks should exercise just as much caution by only using limit orders at posted quotes.
This is because even relatively small orders can cause significant order imbalances in order flows. Individual and institutional clients placing large orders should ask their brokers to route their trades through IEX. IEX maintains a list of retail and institutional brokers connected to their trading platform on its website www. In due course, more exchanges are likely to adopt non-conforming standards, giving all retail investors and their advisers more options. Conforming exchanges will lose revenue as more orders are routed to non-conforming exchanges.
Over time, as suggested by Raman et al. De Simone, Joseph, Jerome J. Roche, and Matthew Rossi. It very much makes sense that there is often never a Nash equilibrium in the stock market, and that is why the stock market is so volatile and fast-paced.
After all, the stock market is a place people go for profit and not equilibrium. Indeed, following this model gives us insight into why the stock market is highly unpredictable. Game theory can however, in some situations, can make it easier to interpret and understand. For instance, there is a mixed strategy equilibrium in this situation. Let us assume q is the probability that majority of investors will go long and 1-q is the probability they will go short. Then, let us assume p is the probability you will go long and 1-p is the probability you will go short.
Solving out this scenario, we can figure out that the mixed strategy equilibrium is that you go long half the time and the majority of investors go long half the time. Even though, this situation and Nash Equilibrium is not particularly telling, other situations could be of use to help you profit in the stock market. September 13, category: Mail will not be published required. Notify me of followup comments via e-mail. This game theory discussion is rather complex because of the large amount of players and different types of players investors, Federal Reserve, governments, corporations as well as the sheer amount of strategies buy, short, hedge, limit orders, stocks, bonds, real estate in the stock market.
In class, we discussed the concept of dominant strategies and strictly dominant strategies. However, those are rather difficult to decipher since other players in the stock market have so many options. In turn, it is unlikely that one option or strategy consistently leads to the highest payoff definition of a dominant strategy. In response, I believe game theory only helps investors at certain times. At other times, it can complicate the process or not even be able to suggest a best response or Nash equilibrium.
To elaborate on this idea, I have created a simple possible stock market scenario below. I have attached the table. The scenario is as follows. TSLA with a holding period of 6 months you are a short-term investor.
If you decide to go long and the majority of other investors in terms of investment capital and investor population go long as well, you both will profit.
If you agree with overall market sentiment, you will profit in the short-term as you can see by the table.