If a month back you knew that Wheat is going to go to historical highs, Oil is going to skyrocket, War would break out and a few million people would leave their homes, you need not go further. Breaking news is not breaking, it's after the fact and has a miserable record of timing the market. Even though the information age started with innovation, it has started consuming us and has become an unruly horse, which even if we could ride, takes us somewhere else, not to the intelligent land, where we want to be. For alpha (intelligence) to happen we need a speed breaker for our emotional response to information, not speed-breakers for information.
Machines will always have an advantage because machines are not emotional (not as of now) and hence can focus better than human emotion, which is unbridled and prone to speculate and war. Speculation is a response to information before it becomes Science and in its essence is a bet on information, a natural sport, tied intrinsically to the study of cause and effect in information, which is hard to quantify, test, validate or prove. Hence, we settle with a psychologically irrational unintelligent, linear response to information.
The intuitiveness of information sharply contrasts with the conceptual age which is open to the idea of effect influencing cause, where information could not just be one thing but many things at the same time, something that is recyclable. The reusability of information is science fiction today. Information is assumed to be a one-way highway, without an exit, they are no cloverleaves, there is no turnaround, a simplicity that allowed 99.99% of businesses to adopt a straight as the crow flies approach to information.
And because everybody has access to the same information, it is the tactical and strategic response to it that differentiates the results. 9 out of 10 investors fail to beat the house and hence fail to interpret the true value of information. This is why it is profitable to be in the information sales business rather than in the information purchase business.
Facebook, Google, Amazon are in some ways in the information sales businesses. They repackage our eyeballs and sell them back to us as services, products, and stickiness. We spend our time consuming the information which they package and repackage for us. The investment management business is also predominantly an information business. The companies produce information while investors consume and interpret information.
The Indexers, the news wires, the funds, the exchanges are all information producers and sellers. The "house" businesses know that information sells, hence it is busy manufacturing Roulettes called Net Bet, Super Bets, Bet Fair, Bet 365, Fox Bet. Everything is a bet on the information. So be it investment management, sports betting, anything linked with subjective betting and web 2.0 consumption, you, the user, are playing against the house, and are going to be wrong 90% of the time regarding the true intermediate and longer-term value of information and hence far away from beating the house. Odds are stacked against you to create sustainable wealth.
The lack of alternative information theories amplifies the problem. Modern finance is an efficient information theory, a study of causality of factors, be it the statistical, fundamental, or technical approach. Behavioral finance is an inefficient information theory. Rarely do we see an approach, where information is assumed to have a structure, a state, a classifier above the actual content, something that could make information inefficient and efficient at the same time. There are enough ways to conceptualize, formulate and measure, degrees of efficiency and inefficiency at a certain time, in an information byte.
Society is deeply invested in the informational age. We are all playing a game of Jenga. You pinch the assumption and the structure implodes. Actually, the implosion is a recurring experience, it's just that our memory fails us. We pick up the pieces and start building up our frail illusions again.
If we change or shake the informational assumption, we are forced to redefine intelligence. Any machine learning approach taking informational content as an input will output informational content. Artificial intelligence is limited by its informational assumption which is content biased i.e. linear and hence not structural, reusable, recyclable, and hence stale, relevant - irrelevant at the same time. Information in this linear form, if it gets too old is called history, if it's too fresh it is called sentimental, if it's new it is called alternative etc.
Information in its current form does not live in a probabilistic state of failure and success and does not understand a content-agnostic world, can not use a generalized model for everything chronological in nature, can not use proxy data to understand the actual data, does not exist in a contextual space-time realm, where it could be transformed from a ray of light into a spectrum, an important experiment which brought quantum physics to light and challenged our classical understanding of physics. Thinking about information architecturally would change how we look at data, causality, noise, computation, probability and consequently redefine what we think is intelligence. The future would always see the present and wonder how little we knew then.
As we head into the exponentiality of information generation, we have reached the beginning of the end of the information age. Even if we will teach machines our own subjective, emotional ways to interpret information, they will experiment and not hesitate to work with new informational assumptions. And the idea that a generalized informational structure could be an input for a machine to generate an informational structure output is not science fiction. The machine is closer to building an objective unemotional science from the subjective emotional interpretation.
The current speed breaker policing championed by the few, thinking about the access to information as an ethical standoff suggests that it does not matter if you have a Porsche, you have to move slow, control your speed and be respectful of the slowest car on the highway. This somewhere Luddite philosophy has become the new business, making it criminal to drive a fast car on the information highway, making it a comparable sin, like misuse of insider information. These new generations of technologists believe that the next step of evolution is speed breakers on the information quantum highway.
I have no reservations here, in terms of tech that is designed to slow things down, after all, slowing down is technology too and ethics should be an important part of information and its access but my challenge is about how far would we go to restrict fast access in a quantum world? How much unfairness is being committed to juice the informational orange? How effective is multi-millisecond frontrunning even if it makes for great flash crash stories? This fight regarding information access and policing access to the information is the last war of the information age, where no one has to wait for their pigeons to come home, all they have to do is sneak in a faster information-sucking infrastructure closer to the information source.
I have no intention of making a legal case for co-location, which has brought controversy and prison time. My intention is to explain, that high-frequency front running may seem like a sustainable way to generate wealth, but for society to become intelligent, we need newer methods of intelligence extraction, like redefining informational structure, rather than thinking linearly about information.
We have shut ourselves in a room where there is no imagination, conception, and thought beyond the walls. We refuse to open another door, look out of the window, make a new door, or break the wall. We sit there assuming that there is only one door to knowledge and hence only one highway leading to intelligence, and hence assume that causality has an irreversible connection to effect.
The IEX Exchange, the India Co-location scam, the discussion around the order flow ethics referring to it as a Ponzi Madoff scheme is nothing but paranoia, which is good because investment management needs governance, but this paranoia has nothing to do with intelligence, it has everything to do with juicing the last drop out of the orange. If the internet amplified the information age, the speed breakers are bringing the information to a screeching halt.
Like the speed breakers, the case of Dynegy (2005) and later Raj Rathnam also make a case of how we have started using information against each other with a clear focus on materiality, ethics without any scientific regard of how to measure that materiality shows that we don't understand the information in the first place. A part of the society believes meting out disproportionate punishments based on crude informational assumptions is fair game. I don't know if Raj Rathnam's lawyers cited the Dynegy case. I wish they did. Because if they would have reiterated the inefficient information story, just like Jamie Oliver, Raj may have had a truncated verdict.
Jamie Oliver's legal attorney, the hero of this story, educated the judges that information was inefficient and there was no way of measuring the real impact of whether A was the real cause of B. I wish, Raj Rathnam's lawyers would also have cited Madoff's cooked books and how the alpha's compared among the two "villains" of the society. Raj had to be in the top decile performers to really have odds stacked against him.
The duality of hedge fund indulgence with material information vs. information's real intermediate and longer-term effectiveness is neither ambiguous nor nebulous. Information flits between relevance and irrelevance, is a poor predictor, and is nearly immeasurable when it comes to mapping cause with effect. Discretionary expertise is a dying breed. Gurus are stepping out in a world of reputational peril. Even the best of quants lack timing mechanisms, not because timing comes from another galaxy, it is because our current understanding of information lacks a temporal structure.
We the society which sends rockets to space and brings them back for reuse have limited clues regarding when a certain relative performance inter asset spread will widen and when it will converge. A simple return performance spread is at the heart of intelligence and failure. LTCM failed because it got emotionally entangled with its spread. Maynard Keynes remarks that markets can remain irrational longer than you can remain solvent is another way to look at a spread between irrationality and solvency. Spread is at the heart of informational relevance and irrelevance, which linear information can not define probabilistically.
Good news can be bad, good, and meaningless, and bad news can be good, bad, and brilliant, in time. The market has a way to have the last laugh, while it churns information, to confound, confuse and convict, all in time. The Information drift (PEAD) is an observed anomaly. Information worked and failed with different degrees of impact. What kind of market structure caused such an anomaly? What was the reason for a 60-day drift? Why the positive and negative drift? Why was it symmetrical? Why was public information not fully reflected instantly? What was the reason for this partial organic assimilation of news? Why do we call it a surprise? Why the anomaly? Even after nearly 50 years, we have limited clarity on the above questions.
Information generation is relentless and information will continue to propagate and mutate making it impossible to police the speed of access to all the informational transformations hence we have to not only start thinking of information measurability and utility and building next-generation machines that can reduce the skew between information demand and supply but also start questioning our emotional response to information if we want to have a more constructive relationship with information, we have to understand the information before we build machines that add more noise and complexity and agitate the information, making it more meaningless.
Odysseus was well known for his informational engagement. He has traditionally been viewed in the Iliad as Achilles’ antithesis. Unlike Achilles whose anger is self-destructive, Odysseus is renowned for his self-restraint and diplomatic skills. While passing through the land of sirens, known for their luring fatal songs, he orders his men to stuff their ears with beeswax and ties himself to the mast of the ship. Recognizing that in the future he may behave irrationally, Odysseus limits his future agency and binds himself to a commitment mechanism (i.e. the mast) to survive this perilous example of dynamic inconsistency.
The eagerness to consume or instant gratification compared to deferred gratification is what differentiates the investing majority from the Odysseus minority. Investing is a lot about self-restraint. Humans give more importance to today compared to tomorrow, the idea of “now” is more important than to the idea of some distant time in the future. The subject conveniently forgotten called 'Temporal Discounting' explains the systematic tendency for humans to switch towards “vices” (products or activities which are pleasant in the short term) from “virtues” (products or activities which are seen as valuable in the long-term) as the moment of consumption approaches, even if this involves changing decisions which were rationally made in advance.
This bias towards 'Now' predisposes humans towards instant gratification, impatience, poor self-control, impulsiveness, and irrationality. Human preference is time-inconsistent. The Stanford marshmallow experiment was a study on deferred gratification conducted in 1972 by psychologist Walter Mischel of Stanford University. A marshmallow was offered to each child. If the child could resist eating the marshmallow, he was promised two instead of one. The scientists analyzed how long each child resisted the temptation of eating the marshmallow, and whether or not doing so had an effect on their future success. The results confirmed. Though time influences decision-making, humans are prone to poor willpower, vices and resulting in poor investment habits. This is why masses prefer consumption to save, there are more day traders compared to investors and even fewer contrarians looking at worst performers. This is why foreseeing a personal irrationality, manipulating willpower, and tying oneself to a commitment (mast) is a rare feat.
If you replace marshmallows with information, you can understand, why there is everything wrong with the information generating business. If you would want to hold a business accountable for using the knowledge of marshmallow consumption patterns to feed information to a netizen, they are on philosophically weak ethical ground. But then as I said, ethics is a conscious philosophy for the society, not something that lends itself insularly to policing. This brings me to the idea of business models of tomorrow, which create the Odysseys masts for anyone to legally request you to tie them to.
"I want to invest but I am an incorrigible trader who can't stop myself from watching the screen a few thousand times a day, so please tie me up to a mast, and freeze my years, because I can't handle this information, I am an information addict."
Intelligent investing begins with the acceptance that just because trading fees have become zero, you are still betting against the information generators, linear information is a poor predictor, juicing the information is for machines who are now being policed, discretionary skill is old tech, risky, and a hard to acquire a human skill which is not only becoming difficult because of the increasing complexity of information but if you are not careful, you can land yourself in jail, getting a lawyer well versed with the character of linear information might entail search costs and hence is expensive, not understanding the immeasurability of information creates a disadvantage for you in the investing game.
The future begins with the appreciation that investing maturity comes from informational detachment which starts with thinking end of the day and moving towards the Jan 1 to Jan 1 investing, which simply means that investing is so slow that it's no more fun, it's a boring job, for machines.
We have arrived in the conceptual age. The information age is over and now machines will deal with information in a context that is unreadable, unfathomable for human beings. All humans have to do now is to judge the machine. How effective they are doing their job? How good one machine is versus the other? How differentiated is one from the other? These machines are here to speed break our emotional engagement with information and take us away from a trade screen to reading something for the soul and understand that information is a marshmallow and eating too much of it will kill you.