The Future of Finance

It seems clearer and clearer to me that the financial industry is headed for an age of rocket science. An age whereby quantitative and computational finance governed by greeks, complex alogorithms and black boxes would account for an overwhelming majority of trades on exchanges. What would be the future effects of this? Would the traditional investor be disadvantaged? Is it time that all of us should have black boxes of our own?

In this post I would attempt to share my thoughts on this:

What would the future effects of this?
It means that the market will become more and more efficient in such techniques and the profit margin in relation to risks will continue to shrink. The investor will have to on an increasingly frequent basis develop new techniques and ideas, backtest it and roll it out before some hedge fund or large bank comes into the scene. The impact of this on security prices to me is unknown but I guess that prices would become much more volatile as trades become much faster than ever before. Slight changes in economic indicators can have large impact on security prices. More and more people will have to depend on leverage. Then this means there will be counter-techniques whereby institutions with large enough capital to influence prices can front-run or harvest smaller black box players by busting their stop losses or force margin calls. Volume of stocks traded would explode and this would spell well for exchanges.

Would the traditional investor be disadvantaged?
It depends, very much on the whether the investor or trader relies on similar quantitative indicators to make his trades. If he does, then he will surely be outdone by these black boxes and it would be about time he revises his investment framework. Retail investors should keep away from techniques that would pit themselves in direct competition with the big boys out there.

Is it time that we should all have black boxes of our own?
I would say no as a matter of fact. These black boxes will almost wipe out the the arbitrage business of financial securities. It requires strong foundation of financial and programming skills which is not oftenly found in any normal person. However, there is one thing that black box users do not have, that is to have a long time horizon. The quant community by and large do not like to leave themselves exposed to price fluctuations for too long. The buy and hold technique might seem outmoded and dead, but I would say it would depend very much on what you buy and at what price you bought. Blindly buying the indexes, will just allow you to do average. These quant traders would come under increasing stress and pressure to find new techniques and ideas. Whilst true buy and hold investors who have perfected the art would have no such stress.