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Behind the Market Swoon: The Herdlike Behavior of Computerized Trading
- claydavisss 8y agoits amazing to watch the media try to deflect attention from the true, far more worrisome underlying issue: the Fed has spent twenty years fighting the problems of artificially low interest rates with more and longer durations of low interest rates. the current meltdown is the result of the economy binging on debt and becoming too reliant on asset valuations. if the Fed raises rates it will crash asset prices...if it fails to raise rates then hyperinflation results either way the everything bubble will be a crisis for the dollar itself in late 2019 the Fed will do one final massive round of quantitative easing which will ultimately destroy the dollar or you can believe this is about Trump or machine trading...if the economy could be saved by powering down some trading boxes, it would have happened in October
- Banksy_is_Qanon 8y agoIs computerized trading more or less herdlike than human trading, or exactly the same? Popular Delusions And the Madness of Algos !
- satya71 8y agoI suspect it's the same, but operates thousands of times faster.
- ajross 8y agoThis bear market took a week to develop. The crashes of 1929 and 1987 happened in a day. I don't think that point holds.
- bboreham 8y agoWhich particular day in 1929 are you thinking of? October 24 - 11% drop, followed by some recovery. October 28 - 13% drop October 29 - 12% drop The lowest point in 1929 was reached on November 13. The bottom of the crash was on July 8, 1932.
- cultus 8y agoIt's no surpise that it should be herdlike, since the algorithms are operating with much of the same information.
- vasilipupkin 8y agoActually, it works in the opposite direction. Here is why: if betting against the herd was the right thing to do, algos would learn this behavior and all algos would start betting against a big price down move. This is why algos actually reduce volatility, not increase it. And volatility is exacerbated by humans: trade wars, attacks on the fed and general erratic behavior of our president
- xapata 8y agoNo, betting with the herd is the correct bet, except that one needs to place the bet before everyone else does. Algorithmic, low latency trading reduces bid-ask spread under normal circumstances, but increases the risk of extreme events.
- vasilipupkin 8y agoWe had plenty of algorithmic trading and years of very low volatility at the same time. If algorithmic trading increased risk of extreme events, it would have shown up during let’s say 2012-2017 years of low volatility. No, algorithmic trading actually reduces risk of extreme events such as fat fingers or extreme bets by humans. What drives volatility is macroeconomic environment.
- xapata 8y agoYou don't remember any of the "flash" crashes? Turbulence has increased, regardless of the general trend.
- vasilipupkin 8y agoFlash crash of 2010 was extensively investigated and no evidence that algorithmic trading was at fault was found. After that, we had some of the lowest turubulence years on record, while algorithmic trading was going on, so your theory is not supported by evidence.
- cs702 8y agoAs the article points out, passive funds, which have become a dominant force in the stock market, own the same stocks as everyone else in the same proportion. When passive funds as a group have net outflows, all their holdings must be reduced in roughly the same proportion. But passive funds as a group cannot reduce their holdings by selling stocks to each other! It's impossible to take water out of a boat by scooping water from one spot and pouring it back into the same boat in some other spot! Therefore, to reduce holdings, passive funds (or their broker-dealers) necessarily must find other -- i.e., non-passive -- buyers willing to take those stocks at some market-clearing price. Alas, everyone else, in the aggregate, also owns the same stocks in the same proportion. Potentially, this can produce temporary imbalances between passive net sellers and non-passive net buyers that get corrected via declines in price. Passive net sellers, being price agnostic, do not care; they're on automatic.
- module0000 8y ago>> As the article points out, passive funds, which have become a dominant force in the stock market, own the same stocks as everyone else in the same proportion. THIS. This is how it works. They also have similar basis prices for their positions, and similar pain thresholds. It's not a big surprise that when Institution XYZ reaches its' pain threshold and stop loss orders are used, a few more dozen Institution ABC, DEF, and GHI hit theirs also! This looks like a "huge selloff" on a chart, but it's just the same event being experienced by multiple institutions near the same point in time. tldr: it looks like a herd because it is a herd.
- ajross 8y agoHow is that any different from previous bear markets? I swear I remember reading the same analysis in 1987 after the crash. Human behavior (even human-programmed behavior) is pro-cyclic. Everyone wants the same stuff and makes the same decisions with the same input. I don't see anything notable about this market cycle as compared with previous ones at all, only the jargon is changing.
- module0000 8y ago
- hendzen 8y agoMany (if not most) quantitative hedge funds are dollar neutral, which means they have one dollar short for every dollar long. There are typically additional constraints about having equal long/short exposure on each industry and investing style (momentum, value, etc). So contrary to the article, most of these funds don’t take broad bets for or against the market. What they are really doing is correcting the relative valuations of each individual company by shifting bits of capital away from overpriced companies and towards underpriced ones. That doesn’t have the effect of raising or lowering broad market indices. Now there are of course other investors who take broad directional bets on the market but those are probably more likely to be discretionary bets rather than systematic.
- kingkawn 8y agoHow does that not result in a net neutral investment return? Forgive my ignorance if this answer is obvious
- pmalynin 8y agoThe goal is to have zero correlation to the index (called beta). You’re hoping that your long assets will go up in value regardless of what the index is doing (the alpha of the stock). Similarly with your short positions, you’re hoping that they are going to go down regardless of what the index is doing. In a sense you’re eliminating “chance” by driving the beta close to zero and instead are focusing more on what actually makes the company a good investment (it’s alpha)
- deleted 8y ago[deleted]
- steventhedev 8y agoBecause your portfolio is neutral in terms of the market/sector, but not on individual options. A good place to start is to read up on statistical arbitrage.
- vasco 8y agoTo expand on pmalynin's excellent answer with an example: Imagine you think Apple is better than any other technology company and you want to bet it will outperform other technology companies. If you simply buy Apple stock, you might lose money even if it outperforms all other tech companies, in the case that the whole market is going down. Because of the above, you need to devise a strategy that will earn you money on the difference between Apple stock and the overall tech sector stocks. Those strategies usually involve combinations of stock and derivatives and you can optimize your returns vs exposure with simple models.
- AlphaWeaver 8y agoNon paywalled, and cleaner version: https://outline.com/9s3xTZ https://outline.com/9s3xTZ
- based2 8y agofatfinger vs fht
- lordnacho 8y agoFormer fund manager here. Yes, there is herdlike behaviour. But why? Here's a little story about my investment career. I once hired a guy for a fund I was partner in. He was a proper old school equity investor. He'd fly around the world to different countries and visit businesses. He'd think about each country's prospects, each industry, and each company. He'd meet withe the CEOs and look them in the eye, and ask them whether his company was gonna make money. I shit you not. He's come back to the office and share his thoughts on why one country was good, why this industry, why this business. It was a different story each time. Another guy I worked more closely with on a fixed income desk. We'd think about different countries, their bonds, their IR rates, swaptions, etc. There's be some global stories inevitably, but a lot of local ones too and we'd chat about what to do in our trading book. Then there was quantitative FX trading, another one of my projects. We'd look at things that affect currencies, patterns in the prices, anything you might imagine arrives as a live feed. And we built the infrastructure to trade the regularities that we found. Quite a lot of research and execution infrastructure. But at the end of the day, the computers are doing what? Looking at a variety of information and judging what will happen. Just like my two colleagues. Fast forward to the last few years. Pretty much every conversation I have with anyone in the investment business talks about one thing: QE and zero rates. There's only one thing that matters for everything now. When interest rates are really low, what happens? Everything is worth buying. Buy houses, buy stocks. Buy them in the developed countries, buy them in EM. Sell options. What used to be a conversation containing rates as an ingredient has become a conversation only containing rates. People, and computers which learn what worked for people in the recent past, have gone from a rich market conversation about many things to one about just QE. It will be interesting to see what happens in the near future. I can't think of a lot of bubbles that were deflated in a controlled manner. And I also expect more differentiation in equity debates. Company does this, industry does that.
- rayvy 8y ago> Yes, there is herdlike behaviour. But why? > People, and computers which learn what worked for people in the recent past, have gone from a rich market conversation about many things to one about just QE. So are you saying that in the past N years since QE and 0 rates, the parameters that define which assets/resources to buy/trade have gone from wide-ranging (e.g., "We'd think about different countries, their bonds, their IR rates, swaptions, etc"), to singular (e.g., "...has become a conversation only containing rates.") ? How does this tie back into the "herd-like behavior" comment? Are you saying that every algo trader is only focusing on rates because that (more so than anything else), is determining where to allocate capital?
- deleted 8y ago[deleted]
- User23 8y agoIt’s those evil computers! Pay no attention to the central bank behind the curtain.
- m0j0e 8y agoClifford Asness sums up my feelings about this article pretty well: https://twitter.com/cliffordasness/status/1077757633472299008?s=21 https://twitter.com/cliffordasness/status/107775763347229900...
- rdlecler1 8y agoMarkets are moving much faster but we’re still using the same scale on the x axis (time). We’ve seen a 4,000 point drop so far but if that occurred over a one year period we would have called it a recession. However if the market recovers in the next few months we’ll interpret this as the continuation if a 10-year bull market.
- WalterBright 8y agoHumans exhibit herdlike behavior when investing, too. It's why the term "contrarian" exists (a person who bets against the herd).
- deleted 8y ago[deleted]