Real-Time Risk

Risk management solutions for today's high-speed investing environment

Real-Time Risk is the first book to show regular, institutional, and quantitative investors how to navigate intraday threats and stay on-course. The FinTech revolution has brought massive changes to the way investing is done. Trading happens in microsecond time frames, and while risks are emerging faster and in greater volume than ever before, traditional risk management approaches are too slow to be relevant. This book describes market microstructure and modern risks, and presents a new way of thinking about risk management in today's high-speed world. Accessible, straightforward explanations shed light on little-understood topics, and expert guidance helps investors protect themselves from new threats. The discussion dissects FinTech innovation to highlight the ongoing disruption, and to establish a toolkit of approaches for analyzing flash crashes, aggressive high frequency trading, and other specific aspects of the market.

Today's investors face an environment in which computers and infrastructure merge, regulations allow dozens of exchanges to coexist, and globalized business facilitates round-the-clock deals. This book shows you how to navigate today's investing environment safely and profitably, with the latest in risk-management thinking.

• Discover risk management that works within micro-second trading
• Understand the nature and impact of real-time risk, and how to protect yourself
• Learn why flash crashes happen, and how to mitigate damage in advance
• Examine the FinTech disruption to established business models and practices

When technology collided with investing, the boom created stratospheric amounts of data that allows us to plumb untapped depths and discover solutions that were unimaginable 20 years ago. Real-Time Risk describes these solutions, and provides practical guidance for today's savvy investor.

Acknowledgments xi

Chapter 1 Silicon Valley is Coming! 1

Everyone is into Fintech 3

The Millennials are Coming 7

Social Media 9

Mobile 10

Cheaper and Faster Technology 13

Cloud Computing 14

Blockchain 15

Fast Analytics 15

In the End, It’s All About Real-Time Data Analytics 18

End of Chapter Questions 19

Chapter 2 This Ain’t Your Grandma’s Data 21

Data 21

The Risk of Data 23

Technology 27

Blockchain 30

What Elements are Common to All Blockchains? 31

Conclusions 39

End of Chapter Questions 39

Chapter 3 Dark Pools, Exchanges, and Market Structure 41

The New Market Hours 51

Where Do My Orders Go? 52

Executing Large Orders 54

Transaction Costs and Transparency 56

Conclusions 57

End of Chapter Questions 57

Chapter 4 Who is Front-Running You? 59

Spoofing, Flaky Liquidity, and HFT 64

Order-Based Negotiations 78

Conclusions 80

End of Chapter Questions 81

Chapter 5 High-Frequency Trading in Your Backyard 83

Implications of Aggressive HFT 89

Aggressive High-Frequency Trading in Equities 96

Aggressive HFT in US Treasuries 98

Aggressive HFT in Commodities 99

Aggressive HFT in Foreign Exchange 101

Conclusions 102

End of Chapter Questions 102

Chapter 6 Flash Crashes 103

What Happens During Flash Crashes? 104

Detecting Flash-Crash Prone Market Conditions 116

Are HFTs Responsible for Flash Crashes? 124

Conclusions 126

End of Chapter Questions 127

Chapter 7 The Analysis of News 129

The Delivery of News 130

Preannouncement Risk 139

Data, Methodology, and Hypotheses 143

Conclusions 154

End of Chapter Questions 154

Chapter 8 Social Media and the Internet of Things 155

Social Media and News 160

The Internet of Things 165

Conclusions 169

End of Chapter Questions 170

Chapter 9 Market Volatility in the Age of Fintech 171

Too Much Data, Too Little Time—Welcome, Predictive Analytics 174

Want to Lessen Volatility of Financial Markets? Express Your Thoughts Online! 175

Market Microstructure is the New Factor in Portfolio Optimization 176

Yes, You Can Predict T + 1 Volatility 178

Market Microstructure as a Factor? You Bet. 179

Case Study: Improving Execution in Currencies 183

For Longer-Term Investors, Incorporate Microstructure into the Rebalancing Decision 184

Conclusions 185

End of Chapter Questions 185

Chapter 10 Why Venture Capitalists are Betting on Fintech to Manage Risks 187

Opportunities for Disruption are Present, and They May Not Be What They Seem 189

Data and Analytics in Fintech 191

Fintech as an Asset Class 192

Where Do You Find Fintech? 194

Fintech Success Factors 194

The Investment Case for Fintech 196

How Do Fintech Firms Make Money? 198

Fintech and Regulation 198

Conclusions 200

End of Chapter Questions 200

Authors’ Biographies 201

Index 203

IRENE ALDRIDGE is managing director and quantitative portfolio manager at ABLE Alpha Trading and president of ABLE Markets. She is author of Searching for High-Frequency Trading Opportunities and High-Frequency Trading.

STEVE KRAWCIW is CEO of ABLE Markets, a leader in market microstructure analytics. His experience comes from such firms as McKinsey & Co. and Credit Suisse, and he is coauthor (with Irene Aldridge) of Quant Investor Almanac 2011.

Technology is developing and changing the way we live and work more and more every day, and in the financial markets it has created a double-edged sword. Today’s investors are more informed and have more access to a broader range of investments than ever before, but they’re also exposed to unprecedented risk at a moment’s notice. Real-Time Risk shows all types of investors how to fully benefit from the data-rich insight and opportunities cutting-edge technology offers, while protecting assets from an always-on market.

Most investors don’t fully understand how much FinTech has fundamentally changed the face of finance and investing. Do you know there are now twenty-one national security exchanges? Do you know allocating to stocks favored by high-frequency traders will improve a long-term buy-hold strategy? Do you understand how regulation will limit or expand your options tomorrow? This accessible treatment focuses on the impact—both documented and perceived—FinTech disruptions have on companies and how investors can profit from market reactions. FinTech is not only ushering in an unprecedented way of doing business and investing but also establishing its own asset class for investors to grow wealth while these startups continue to disrupt the industry and take market share. This proven authorial team, experts in cutting-edge quantitative and high-frequency trading, fully positions you for success in the new reality of growing wealth by putting at your fingertips the ability to:

• Explore in-depth the blatant and not-so-obvious ways high-frequency trading impacts your investments
• See why market microstructure is no longer just for execution traders and market makers and how long-only strategies suffer by ignoring it
• Develop a balanced, data-driven perspective on global markets to make more informed investment decisions

Navigate today’s investing landscape safely and profitably with Real-Time Risk.