We shouldn't exist, but we do
Earlier this week we had a guest lecturer for our Software Engineering Workshop course (SENG3011 for those at UNSW). The guest was Andrew Maxwell from Optiver, a Dutch trading firm that has a strong Australian presence and invests heavily in IT solutions to facilitate their business (both for algorithmic traders and their human counterparts).
Usually guest lecturers are far more interesting than their internal counterparts as they bring an applied perspective and experience, and Andrew was no exception. While there was not enough time to go into depth on their operations, he gave a broad outline of Optiver's approach to both trading and the software development behind it. While this was interesting, what stuck with me was the recurring theme that reality and theory often disagree with each other.
You might be thinking "Well that sounds extremely obvious" and I would agree with you, but when combined with the examples from Andrew's previous work it provided a lot of food for thought. Initially he applied this principle when discussing varying algorithms, and how different worst, average and best case complexities were sometimes useless in making decisions, as the size and distribution of data rarely lined up with any of these scenarios.
The next example was of a team of recent Ivy league mathematics/CS graduates that had created a sophisticated machine learning algorithm for algorithmic trading. The project was billed as a money making machine. The only problem was that when they implemented it, the algorithm was so complicated that they couldn't understand why the program was making the decisions that it did, and when the market turned so did the profits.
Most sticking of all, was the following statement:
Theoretically, Optiver shouldn't exist
Optiver trades equities not based on their projected future value, but on what their current value is. However according to free market theory, the 'invisible hand' of the market will price everything in the market at its actual value. Therefore, how can Optiver make a profit if everything is already priced at its true market value?
The answer is that the in order for the 'invisible hand' to operate, market makers are required to continuously buy and sell to keep the price of goods and services in line with their value. Optiver is one of those market makers, and I'm sure they earn a hefty chunk of change in this capacity.
This makes me wonder, how many ideas and opportunities have I seen or heard that I immediately dismiss because I think "that company shouldn't exist", simply because I don't believe there is a market, or theoretically I can't see it being worthwhile?
Investment Funds consistently beating the market - that shouldn't exist.
Dominoes selling pizza for $5 when labour costs $15 an hour - that shouldn't exist.
A $19B messaging application that's only 5 years old - are you dreaming!!
I used to see opportunities, but more and more I see problems instead. I want to reverse this trend so that when presented with an idea, I see potential before I see potential problems. This has been an issue for me in recent years, however it has been at the forefront of my mind since the talk from Optiver.