Staring at his computer screen, a trader watches his position heading south. Stock XYZ is tanking. About ten seconds later, a second dealer offers 1,000 shares in XYZ, up 1/16. The trend is reversing.
The stock's underlying value slowly moves north, driven by informed traders who react to market fundamentals, such as positive-earnings surprises.
The first trader then unloads his position, making a modest profit. Cool as a breeze, he allows himself a sharp guffaw before plunging back into the market.
What the heck, he tells himself, buy another 1,000 shares of XYZ. Now, the market makes him modestly rich on paper. Boy, was that easy.
A trader in another environment would have given high fives to his buddies. But not this guy. The problem or perhaps the beauty is that he's playing a game on I-SMARTS, the interactive securities-market trading simulation.
The trading system is the brainchild of Robert Schwartz, finance professor at New York's Baruch College, and Bruce Weber, assistant finance professor at New York University in downtown Manhattan.
I-SMARTS, which is DOS-based, features five fictitious traders each with funny names, such as Tuna and Dog. And the buzz is that it is the only system available that adequately replicates several separate markets: quote-driven markets for dealer orders; order-driven markets for customer limit orders; and a call auction with periodic matches.
I-SMARTS is not perfect, of course. It is not networked and is only programmed to trade a single stock, which has no fundamental information (though it does post the prices on its last 15 trades).
The system itself really only allows trading in 99 units, or 9,900 shares, though the live trader could enter a block order of more than 10,000 shares. But that would trigger market impact and render ongoing trading meaningless under current parameters.
The absence of a SelectNet and SOES functionality for dealer trading, as well as orders residing on simulated electronic communications networks, might also be viewed as a limiting feature.
But the game tries hard to be realistic. Each trader starts with no cash, and can accumulate long or short positions over several hours. A market index gives traders a performance measurement. (A history of a trader's decisions is available).
To stimulate traders' attention under research conditions, Schwartz and Weber give out cash authentic legal tender based on their performance.
"After half an hour of trading on I-SMARTS, I said to one guy from the industry, You've made enough. We'll buy a Big Mac with your $5,'" Schwartz recalled with a laugh. "My experience is that it is not easy to make money trading."
The two academics developed simulations that are not purely random, meaning that buying and selling pressures, for example, do not strictly follow textbook economics models, but patterns analogous to real-world conditions.
Experimental Conditions
While the academic field of experimental economics has cranked out volumes based on studies of networked or electronically-connected participants playing the roles of traders entering bids and offers, I-SMARTS is distinctly different.
Three marketplaces can be commingled simply by clicking on a menu. Equally important, it is programmed with order-flow scenarios and other market parameters that would test the nerves of the most seasoned buy-side and sell-side traders.
Machine-generated orders, for example, can be programmed to arrive every 30 seconds, while intra-day volatility can be sent to move within a 20-percent range. Increments can be adjusted from fractions to decimals at the touch of a keystroke.
Want to have your order flow preferenced? Simple.
"So you say, Hmm, preferencing is nice. I can get order flow without being competitive,'" Schwartz explained. "Then you play the game to see just how much more difficult it is to control your inventory."
Schwartz's and Weber's collaboration stems from painstaking research each has done separately on market simulations. Schwartz previously researched order-driven markets with academic peers Kal Cohen, Stephen Maier and David Whitcomb, while Weber's dissertation was on quote-driven markets.
"What makes our system so close to the real thing is that the machine generates a lot of activity," Schwartz said. "The computer is sort of like exogenous order flow that will react to what the participant does, triggering momentum or contrarian activity."
The system is used by attendees at an annual global equity conference in Geneva, hosted by Schwartz and Weber, as well as in classroom settings at Baruch. Nasdaq, which has financed part of the development, is carrying a dealer version on its web page. The recently formed Security Traders Institute, the training affiliate of the Security Traders Association, will use I-SMARTS in classes.
Despite the best talk of Schwartz and Weber, however, I-SMARTS is unlikely to produce, any time soon, the pure unadulterated andrenalin rush of an authentic dealer's desk. Ask some traders.
"I have never been a fan of these systems," said Jim Volk co-head of institutional equity trading at D.A. Davidson & Co. in Portland. "If I am training a guy, would I use it? No, I would put him on the desk for six months and have him yelled at. You have to learn on the job."
Another trader takes a different view. "[I-SMARTS] is not the real thing, but I think aspiring traders could learn a lot from it," said David O'Shea, head of equity trading at New York-based Needham & Co.
Hollerin' Joe
Schwartz and Weber are painfully aware that the most mild-mannered trader can be transformed from a Gentleman Jim to a Hollerin' Joe within seconds.
To that end, they are toying with a CD-Rom version, possibly carrying a background cacophony of human voices.
"Anyway, when we network [I-SMARTS], some of the participants will be drawn naturally into the environment of [a noisy trading room]," Schwartz said.
Still, I-SMARTS does allow the novice and veteran traders and individuals with an interest in how trading works, a good hands-on feel without serious loss of money.
But is I-SMARTS more than a toy and educational tool? Schwartz thinks it could be used "as a screening device to separate the chaff from the wheat when a desk is hiring."
Moreover, a lot of traders are intuitive, he pointed out.
"An aspiring trader may sit down and use [I-SMARTS] and see if he has that intuition," he said.
