Economics & Finance

Who Wins the Market: The Swift or the Smart?

In the business world, fast technology and data are vital resources.

Who Wins the Market: The Swift or the Smart?
In the business world, fast technology and data are vital resources

As we saw with the GameStop controversy, the stock market can be rather volatile. Stock market participants are busy attempting to improve their chances of making a profit by gathering more accurate data and developing more efficient trading algorithms.

The combination of rapidity and knowledge is intriguing. Keep in mind that converting information into profit is a major motivation for traders. It might be as simple as a tweet or as complex as a thorough examination of a company’s shares.

Not all information is time-sensitive, although that is a prevalent trait among many types of data. The imminence of a public announcement is one possible cause of time-sensitive urgency. So, a trader’s ability to act quickly is of the utmost importance; any delay in doing so caused by connectivity risks becoming previously private knowledge public and thus obsolete. Traders compete with one another, some of whom may exchange knowledge that gives them an advantage. If a trader with potentially lucrative and secret knowledge does not move swiftly, another trader is likely to acquire the same information and make purchases or sales in response. The value of the information exchanged is reduced because it has effectively become public knowledge.

The ideal trading conditions call for a high level of knowledge and a rapid reaction time. The catch is that neither one is free. Organizations in the trading industry spend significant effort to gather reliable data. Companies either pay for data, engage researchers, or invest in machines specifically designed for data analysis. You have to pay a lot for reliable data.

Also, there is a high cost associated with frequent trading. To get to the marketplace quickly, you need a reliable and lightning-fast internet connection. In order to put trading methods into action, it may be necessary to hire a big (and costly) execution crew, depending on the structure of the market. Speed in trading also takes into account compliance and due diligence. Adding more workers to the back end to enhance the risk management process and speed up execution is a win-win.

A quick trader will always have more reason to learn as much as possible. Equally, a trader who has more information to draw on has greater motivation to train for speed. Which is why it’s crucial to have both speed and information at your disposal. Which one is more crucial, and how should traders allocate resources between improving their own speed and their information infrastructure?

Investing in speed or information

My colleague Shiyang Huang and I developed a model to decouple the acquisition of speed and knowledge by investors, and we’ll be publishing it in Management Science soon. We found that speed and access to information had important implications for determining market prices.

Who Wins the Market: The Swift or the Smart?
Investing in speed or information

The model provides a theoretical basis for distinguishing between the situations in which speed and information are mutually supportive and those in which they are mutually substitutable. The truth is that it depends on the state of development of both technologies. When both parties are economically weak, they balance one another out. Investors are incentivized to buy more speed and information as a result of a rise in the availability of these technologies. In contrast, they may effectively replace one another after they have reached a certain level of development. improved conditions Investors’ need for knowledge falls as the speed of already-existing technologies increases. Additional data is needed to untangle this complex interconnection.

Read more: The Increasing Significance of Soft Skills in Productivity

The effects on the integrity of the market as a whole were also taken into account. Two of the most important functions of the financial market are resource allocation and information aggregation or reflection. Several aspects of this “price discovery” function are influenced by advances in information and communication technologies. When more resources are devoted to information technology, the truth is uncovered in more depth, increasing the total quantity of price discovery, but when more resources are devoted to speed, the process is only accelerated.

Assume, for the sake of argument, that a genuine price is $100. You can learn 90 in a week if you have access to good knowledge, but in only one day if you have access to faster-than-light communication technologies. Our model predicts an interesting impact when market players have complete discretion over how much to invest in each technology: Modern information and communication technologies may slow down the market as a whole by obscuring prices. This occurs when speed technology is combined with information technology. As a result of the increased desire for speed brought on by the advancements in information technology, more individuals are now able to find 90 in a single day. Nevertheless, if they realize that many other people have come at the same price on the same day, they are likely to lose interest in learning more. Hence, the reality of 100 will never be completely revealed via the price discovery process, which will instead halt at 90.

Discovering a fair price is crucial because it establishes a benchmark against which a company may compete. A company might suffer irreparable harm if the market is not active in price discovery, as seen by the recent case of GameStop, which saw dizzying market highs and lows. GameStop’s upper management would like regular market circumstances in which to evaluate real investment prospects, as opposed to the frenzied trading pressure of the past several months. GameStop will have to wait till the stock market calms down before making any substantial investments due to the current craze.

Standard of the Stock Market

Anyone interested in learning more about how technology has altered market quality, and more specifically, price discovery, will find our work to be of great value. Having more data allows for more accurate stock valuations, which better represent reality. But, in today’s fast-paced business world, data must move quickly.

Who Wins the Market: The Swift or the Smart?
Standard of the Stock Market

Moreover, the market’s ability to aggregate information is influenced by developments in high-speed technology. The first ripple effect of ubiquitous, low-cost speed would be an increase in overall competitiveness as a result of everyone’s increased need for immediate gratification. A large number of rapid traders flood the market in a short amount of time. As traders won’t be incentivized to spend money on knowledge in the long term, everyone will wind up with a smaller share of the pie. When it comes to technical advancements, gaining speed is simpler than gaining intelligence.

In the end, our work serves as a cautionary story about how the disorienting consequences of technological progress might undermine financial markets’ ability to accurately price goods and services.

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