(iStockphoto)
Today marked another triple-digit move for the Dow Jones Industrial Average, which closed up 272 points. Of the 45 trading days over the last two months, 28 of them (including today) have seen triple-digit moves, meaning the Dow has gone up or down by 100 points (or more) 62% of the time since July 25. The average daily move for the Dow during that time has been 188 points, or 1.6%. Here’s a snapshot showing the performance of the Dow over the last two months:
Pretty choppy, right? I’m no stock market historian, but I’d imagine that you’d be pretty hard-pressed to find such a sustained period of volatility. Which brings up the question: what’s causing this? Obviously, there is a lot of uncertainty (and fear) in the market right now. From Europe’s sovereign debt problems, to America’s toxic political climate, to the sputtering global economy, there is a lot to be anxious about. Anxiety breeds indecision, which characterizes the bumpy market pretty well.
There’s also been a lot of speculation about how much high frequency traders are driving the choppiness. These guys are pretty much the only ones who have been consistently making money the last several weeks. High-frequency traders feed off of volatility. No matter which way the market moves, they can make money by taking advantage of tiny price differentials, trading in and out of stocks in fractions of a second. But feeding off of volatility is very different from causing it.
In a recent op-ed, Manoj Narang, founder of the HFT shop Tradeworx, insists that high-frequency trading is not driving volatility. Rather, it’s media exposure and access to markets that is really driving it. Narang writes:
From 2000-2006, the S&P 500 moved an average of 0.37% per day when the market was closed (that is, between the close of one day and the open of the next), whereas from 2007 onward, it moved 0.61% per day during this period, a 65% increase. Logically, it is impossible to blame high-frequency traders for this 65% rise in close-to-open volatility, because there is no trading when the market is closed. This volatility reflects one thing and one thing only — markets react to news, and since 2007, there has been an abundance of news which has caused investors to panic.
This 65% increase in volatility is particularly revealing when it is juxtaposed against the comparable difference when the markets are open. From 2000-2006, the S&P 500 moved an average of 0.76% between the open and close of the same day, compared with 0.85% since 2007. In other words, volatility during trading hours has increased only 12% during the exact same period when volatility during non-market hours has increased 65%, less than a fifth of what would be expected.
Still, regulators remain increasingly skeptical about the world of computer-driven trading. According to a Reuters report earlier this month, the SEC and FINRA have asked high-frequency firms to hand over details about their proprietary trading codes. It remains to be seen whether they hold any secrets to what’s behind all the market volatility.
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Algorithms. They’re everywhere and they’re all looking for the same things, small correlations in the market where short-term gains can be made. that’s why the moves are so big. They all pile on the same type of trades until it is saturated, then they all jump out.
Not just saturated, but oversaturated. At a guess, this automated trading would work fine if only one entity was doing it. When many do, they all see the same opportunities, and jump on them as if they were the only ones trading. Collectively they overshoot the appropriate price point, creating yet another opportunity, and bingo! Positive feedback.
this blog on computer trading maybe useful – http://bit.ly/mRgh8K
as may this recent report from the uk http://bit.ly/qaSbrK
The profits extracted through High Frequency Trading is nothing by a deadweight loss on the market. The whole point of the stock market is to allow firms to raise capitol to make worthwhile investments. Having private third parties effectively set themselves as a taxing authority, adding whole or fractions of a cent to every trade, is simply wrong and it brings no benefit to those trying to use the market for its intended purpose. Regulators or the government should step back in and kick these penny shavers out the door by using transaction fees and other such mechanisms.
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@Mike B
The stock market is an exchange of ownership in a company that has ALREADY raised capital through either a stock offering or an IPO.
” [HFT] brings no benefit to those trying to use the market for its intended purpose”
The people using the market are investors, not the company. Maybe the company might want to go back to investors to raise more capital, but not necessarily. Besides, sometimes the only reason a company goes public is so they executives get a big pay day. See Bankrate.com. They went public a few months ago only so that they could use the money raised from the IPO to pay themselves huge consulting fees. What economic benefit is that?
Hypothetically, the company doesn’t really care where it’s stock is being traded on the open market if it has all the capital it needs. If the executives’ compensation is tied to stock price, then they care, big time, but if not, the only reason a company would even care is that they might buy back some of their shares if they feel the price is too low (see BRK.A).
So HFT does not represent a deadweight loss at all, it is a zero sum position that attempts to profit on small discrepancies in prices. A tax on financial transactions would be a deadweight loss, because it would mean that trades that could be happening are not, bc of the tax.
The losers to HFT aren’t really the investors or the companies whose stocks are traded. The losers are the market makers who owned the seats on the stock exchange.
The economist recently had an article about how and why international stock indices are closely correlated. Sentiment of US investors causes money to flow in Far East stock exchanges and vice-versa. There is no market closed. Even when your market is closed, foreigners are planning buy/sell orders for your market.
@Dave C
Sorry, accidentally downvoted your comment. I agree with you.
Wall street traders benefit more from a volatile market, because they are so close to the data, and with various options, shorts sells, etc. they can make money on a volatile market.
Wall street traders have the most influence on stock price.
Why are we surprised at volatility.
@Alex
Your logic is fundamentally flawed. Based on your concepts of financial markets, the traders would ALWAYS have the incentive to CAUSE volatility. So why are we only seeing a rise in it now?
BTW: short term trading is a zero some game. So for every Wall Street trader making money, another is losing it. Retail investors are not moving the stock market.
I think it is just pure fear. Everyone knows there are huge overhanging debts in the markets. Investors believe a lot of this debt will eventually default but have no clear idea which companies or sectors are likely to be standing after the collapse let alone which ones would actually make money. Hence, money is running around the world in a panic alighting on any temporary strength only to run away at the first sign of weakness.
Whenever a trend starts to peter out and the consensus of opinion starts to be challenged, you frequently see market prices swing and get choppy (particularly in stocks that have been widely popular.) Opinion takes a while to change. It is the same thing one sees when the underlying conditions change radically beneath an otherwise smooth, steady, yet forceful surface wave—the wave begins to oscillate violently, which is otherwise known as “wave shoaling”. The recent volatility in the market is just a reflection of the intensity of the bullish and bearish forces at work on the market. The really interesting question is which side will win out within the next couple of months?
It’s not ‘computers’… the greater the number of computers engaged in trading the more ‘reversion to the mean’ we should have .. the computers are just executing programs written by many different people. Each of those code snippets are as different and as unique as the individuals setting them up .. people with the same convictions that they must sell a stock at price “X” because it can’t go up any more while the guy across the hall is buying it because he thinks price “X” is a bargain.
“Any sufficiently advanced technology is indistinguishable from magic” – Arthur C Clarke.
High Volatility indicates there are only a few big individuals, companies, or countries involved with those massive trades. They are likely funneling the same trades through thousands of accounts so they look like many fractured forces and not the huge army in there mucking around.
It’s not magical computers .. you need to get out your tinfoil hat.
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