Wednesday, May 12, 2010

 

The Crash of 2010: What caused it?

On Thursday, May 6th at approximately 1:40 p.m. Chicago time, the stock market completely fell apart and dropped about 5% over the next 5 minutes. The reason this happened is pretty simple. Many of you might remember the advent of the day trader in the late 90s. A lot of those guys managed to stick around and were still trading stocks up at least until a couple of years ago. But if they survived the fire of learning to trade there is a good chance they have been burned by the computer algorithms that have become the primary market makers on stocks controlled by about 20 trading companies and banks. My evidence is anecdotal, I am not a stock trader but I do know enough people who trade them and the big problem they have with computer driven high frequency trading is that human beings are incapable of moving as quickly as computers. Listen to this guy because he explains it better than I do:



In a nutshell, a small group of companies have replaced thousands perhaps tens of thousands of small traders. When the hand full of companies that control the computers decide to turn them off then there is no market because the little guys have been driven out of business.

Over the past two decades, stock trading has gone from a relatively transparent network of human "market makers" executing buy and sell orders at a handful of exchanges to an almost entirely computer-driven system fragmented among dozens of players. And regulators don't have the ability to directly monitor many of these new players.


I hope I don't need to tell you why it is better to have thousands of the little guys making markets versus a small group of companies that rely on computer algorithms. What happened last Thursday is a warning- at some point those computers will get turned off again in the middle of a market panic because all of those computers are doing the same thing.

When the stock market is in panic mode, ultra-fast computer systems can't help keep prices fair, and they have fewer incentives to stand in the way of a falling market.


Ironically, human traders are flawed so they make bad decisions and that actually is better for providing liquidity than algorithms that quickly flash bids and offers and just as quickly can be shut off leaving the market with no liquidity.

All markets need humans making markets in order to provide liquidity. Without liquidity there is no market and 5% plunges in less than 5 minutes can happen. I am not saying that crashes won't happen with humans making the trading decisions but they will likely happen less gradually. That is the lesson the last time the big investment banks let computer algorithms make buy and sell decisions.

Computerized Program-Trading Should Be Banned.



More later.

Labels:


|

<< Home

This page is powered by Blogger. Isn't yours?