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Robot Wars Hit Wall Street

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Firms stockpile arsenals of technology to annihilate the competition.

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It's hard to keep track of the untold spin-offs of the original Terminator movie -- but I wouldn't be surprised if the next installment is set on Wall Street.

Why, you ask? Because computers are now running the economic show, and they -- like the Terminator's eponymous robots -- seem to be engaged in a pitched battle to the death.

Dramatic market moves have become commonplace, and those looking for a fundamental explanation are missing a significant structural change: The majority of stock trades now originate with so-called "high frequency" funds, which use computers programmed with obscure mathematical correlations to execute trades. The computers trade in and out of stocks at light speed, sans human intervention -- no trader, no economist, no chart tracker. These funds argue that computers aren't swayed by emotion, and naturally move much faster than a person ever could.

Ushered out is the model of fundamental investing that lasted a century. Still, humans must program the computers, and they're not infallible (see the 1998 collapse of Long Term Capital Management).

These funds are generating almost three-quarters of all US equities trading volume, the Tabb Group, a consultancy, recently estimated. Five years ago, the fraction of total trades carried out in this way amount was estimated as less than one-quarter. Some of the funds are household names -- Renaissance Technologies and Goldman Sachs (GS) are 2 of the biggest players -- but others, like GETCO, Peak6, RGM Advisers, and Hudson Bay, aren't. Many are based in Chicago, and emerged from the city's options trading pits. Other hedge funds run by the likes of Bank of America (BAC), Morgan Stanley (MS), Citigroup (C), and
UBS (UBS) also have used the strategy.

Their presence has expanded quickly following the start of the bear market: Hedge funds and money managers lost money and dropped out in droves. They use trading strategies that arbitrage minute differences in share prices and trading speed -- known as latency -- between exchanges and other trading venues.
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No positions in stocks mentioned.

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