Automated trading and Wall Street volatility

Since the 2008 financial crisis, investors have increasingly turned to computerised trading systems based on economic data, utterances of central bankers or complex artificial intelligence software that employ algorithms.
Since the 2008 financial crisis, investors have increasingly turned to computerised trading systems based on economic data, utterances of central bankers or complex artificial intelligence software that employ algorithms.PHOTO: REUTERS

NEW YORK • The recent tumult in US financial markets has shone a light on the rising role of automated trading on Wall Street and whether it is exacerbating volatility.

Since the 2008 financial crisis, investors have increasingly turned to computerised trading systems that have been programmed to render quickfire "buy" and "sell" orders based on economic data, utterances of central bankers or complex artificial intelligence software that employ algorithms.

Though set up by humans, these trades are based on a snap assessment that lacks the subtle discernment of the human eye.

Whenever an unexpected lurch on Wall Street slams investors, fingers are pointed at such systems that increasingly dominate trading.

Critics have questioned whether the market's recent swoon - which could result in the worst December since the Great Depression - is due to a liquidity drain and other unanticipated effects of the computerisation of trading, rather than fundamental economic factors at a time when US unemployment is low and economic growth is solid.

Treasury Secretary Steven Mnuchin, in a recent interview with Bloomberg, blamed the uptick in volatility on the surge in high-frequency trading, a type of automated trading.

Trading from quantitative hedge funds relying on computer models now accounts for 28.7 per cent of overall volumes in the United States, according to the Tabb Group consultancy. That is more than twice the share from five years ago and, since last year, above the percentage held by individual investors.

JPMorgan Chase analyst Marko Kolanovic estimates that only one-third of the assets in the stock market are actively managed and only 10 per cent of the daily trading volume is the result of specific deliberation.

But while the rise of automated trading is undeniable, it is less clear that it is responsible for increased market turmoil.

Tabb Group founder Larry Tabb said most electronic trading firms use algorithms that identify and take advantage of discrepancies between the price of a given security and what it fetches elsewhere.

He added: "Most models actually dampen volatility rather than enhance volatility."

But he concedes that the proliferation of exchanges where stocks are bought and sold can result in limited liquidity on platforms. That can make markets vulnerable to a "flash crash".

AGENCE FRANCE-PRESSE

A version of this article appeared in the print edition of The Sunday Times on December 30, 2018, with the headline 'Automated trading and Wall Street volatility'. Print Edition | Subscribe