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Mapping Trader Behaviour 16 th February 2010 CCFEA Workshop

At the 2010 CCFEA Workshop, David Norman explored the complexities of trader behavior and its implications for the financial markets. He emphasized how biases in decision-making adversely affect market dynamics, referencing key works such as those by Tversky, Kahneman, and Andrew Lo. The presentation highlighted the challenges faced by the trading industry, including fragmented market structures and unprecedented losses in the banking sector following the Great Recession. Through understanding human behavior in trading, Norman aims to propel the evolution of market design toward more precise science.

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Mapping Trader Behaviour 16 th February 2010 CCFEA Workshop

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  1. Mapping Trader Behaviour16th February 2010CCFEA Workshop David Norman

  2. Introduction • Good morning • The financial markets industry has a problem • Complex behaviours in trading aren’t well understood • Note: Andrew Lo ‘What happened to the Quants in 2007?’ • Decision-making biases influence markets adversely • Tversky and Khaneman, Denis Hilton • Market technical infrastructure structure is flawed • Central repository for trading (exchange) now fragmented (MiFID) • Human behavioural influence is prevalent in global market design • What has this led to? Complexity for its own sake

  3. Industry Update – We haven’t been here before • ‘The Great Moderation’ becomes ‘The Great Unraveling’ • $1 Trillion MBS/toxic loan/ bad debt writedowns • 48,000 job losses on Wall Street • Unprecedented loss of reputation in Banking Industry • Investment bank collapses (Bear/Lehmans) • Massive capital provision from the Bank of England • New Mortgage applications down 90%

  4. Fragmentation in Europe: MTFs • POSIT, a dark-pool MTF operated by ITG, launched in 1998. • Chi-X, launched in March 2007. • Turquoise, launched in August 2008. • Equiduct-Berliner Börse (Project running since 2008). • NASDAQ OMX Europe, launched in September 2008. • Bats Europe, launched in October 2008. • NYSE Arca Europe, launched in March 2009. • Burgundy Nordic, launched May 2009. • Quote MTF, Launched September 2009.

  5. Transformation of Data Users • High Frequency traders • Hedge Funds • Quant Driven • Prop trading groups • Grey Box • Securities desks • Maximum Market coverage • Derivatives market makers • Need Consolidated Feed/Data Aggregation and Display • Order Management Systems • Execution Management systems

  6. Central Limit Order Book

  7. Order/Trade audit trail

  8. What does this lead to? • A better understanding of why traders make decisions to trade • What has been an inexact science can now become an exact science • Past few years most emphasis has been on algo’s that improve the cost effectiveness of trade execution • In addition, there is a premarket stage referred to as the “alpha discovery phase” which is where the quants come in • Now the emphasis is on understanding human decision-making as a central component to designing new markets

  9. Research Focus • Risk: Time taken and time interval metrics • Trader judgment and decision making under stress • Information processing and memory bias • Success and failure clouding • Anticipation, momentum and randomness • Peer group pressure • Opportunity to unravel complexity

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