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Is Computerized Groupthink Endangering Markets?

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I have written to you before about my unease with program trading, especially stop losses (see here and here). Add to that the algorithmic groupthink of computerized trading and it’s a nasty brew.

Today the Wall Street Journal’s Stephanie Yang reports:

On Feb. 5, the Dow Jones Industrial Average suffered its worst one-day point-decline in history amid a tumultuous week for global markets. Although the blue-chip index has since erased that loss, some investors are still trying to puzzle out what caused such a drop.

One possible culprit: a cascade of automated stop-loss sell orders by trend-following investment funds that started in London and then fed into the steep rout in U.S. stocks. In the following days, the downward lurch prompted selling to spread to other assets like oil futures.

This was the conclusion of an analysis of that fraught week by Bridgeton Research Group LLC, which runs computer models predicting trading patterns of algorithmic strategies.

Stop-loss orders, or sell stops, are standing directives to sell a position—say, a stock or exchange-traded fund—once prices fall below a certain level. They have long been a tool for investors to automatically shut down a losing bet.

But the growing influence on markets of algorithmic traders and trend-following funds, which use such automatic directives, potentially makes markets more vulnerable to sharp swings if everyone starts to sell at once. Such strategies tend to have sell stops around the same levels across stock, bond and commodities futures.

“So many of these algorithms are doing the same thing. Their behavior becomes like human group think,” said Peter Hahn, co-founder of Bridgeton.

Read more here.

Originally posted on Yoursurvivalguy.com.

 

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E.J. Smith

Editor-in-Chief
E.J. Smith is Founder of YourSurvivalGuy.com, Managing Director at Richard C. Young & Co., Ltd., a Managing Editor of Richardcyoung.com, and Editor-in-Chief of Youngresearch.com. E.J. graduated from Babson College in Wellesley, Massachusetts, with a B.S. in finance and investments. In 1995, E.J. began his investment career at Fidelity Investments in Boston before joining Richard C. Young & Co., Ltd. in 1998. E.J. has trained at Sig Sauer Academy in Epping, NH. His first drum set was a 5-piece Slingerland with Zilldjians. He grew-up worshiping Neil Peart of the band Rush, and loves the song Tom Sawyer—the name of his family’s boat, a Grady-White Canyon 306. He grew up in Mattapoisett, MA, an idyllic small town on the water near Cape Cod. He spends time in Newport, RI and Bartlett, NH—both as far away from Wall Street as one could mentally get. The Newport office is on a quiet, tree lined street not far from the harbor and the log cabin in Bartlett, NH, the “Live Free or Die” state, sits on the edge of the White Mountain National Forest. He enjoys spending time in Key West and Paris. Please get in touch with E.J. at ejsmith@youngresearch.com.

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