For starters, in equity markets, high-frequency traders (HFTs), who use algorithmic computer programs to follow market trends, account for a larger share of transactions. This creates, no surprise, herding behavior. Indeed, trading in the U.S. nowadays is concentrated at the beginning and the last hour of the trading day, when HFTs are most active; for the rest of the day, markets are illiquid, with few transactions.
This combination of macro liquidity and market illiquidity is a time
bomb. So far, it has led only to volatile flash crashes and sudden
changes in bond yields and stock prices. But, over time, the longer
central banks create liquidity to suppress short-run volatility, the
more they will feed price bubbles in equity, bond, and other asset
markets. As more investors pile into overvalued, increasingly illiquid
assets — such as bonds — the risk of a long-term crash increases.
is the paradoxical result of the policy response to the financial
crisis. Macro liquidity is feeding booms and bubbles; but market
illiquidity will eventually trigger a bust and collapse.
When the next bear market starts we will see huge swings in price because markets are thin (illiquid) because there are no human beings acting as market makers. Just HFT computers that all have similar algorithms and which all will be shut off when things get hairy.
Labels: crash alert, High Frequency Trading, illiquidity, stocks