We are just short of a week since the 8.5% intraday drop in the S+P 500 of May 6. We have yet to hear an explanation from regulators or exchanges As for the market the S+P 500 closed today virtually unchanged from the market open on that chaotic day. So does that mean the whole episode is just something to shrug ones shoulders over and move on.......I hardly think so.
Something is terribly broken. I am developing the concept of a "volatility tax" which is being taken out of returns to investors and cost of capital to corporations throught this activity (this is different than an actual tax levied by a govt ). I am not actually sure any entity is even profiting from this tax or whether it is just a "dead weight" cost to the economy. More on that later.
At the end of his book:
The Quants: How a New Breed of Math Whizzes Conquered Wall Street and Nearly Destroyed It by Scott Patterson
In which he dissects how the quantitative traders took massive losses on their own books and contributed mightily to the market turmoil of 2008 he describes how they were less chastened than interested in moving onto the newest new thing, The new frontier for these guys was lighting fast high speed trading. Patterson points out in interviews that this was likely a new accident waiting to happen. That certainly seems to be the case
Computer Trading Is Eyed
Debate Turns to Absence of Circuit Breakers, Market Makers as Mystery Plunge Is ProbedTraders parsing the mystery of Thursday's stomach-churning stock-market plunge are focusing on whether rapid-fire computer trading, coupled with the market's complex trading systems, triggered a free fall that appears to have begun with an order to sell a single stock...
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.
The Quants' Computers All Sold At The Same Time
And in what may be the ultimate feedback loop some see the hedge fund connected with black swan guru Naseem Taleeb as responsible at least in part for last week's black swan 900 point drop in the dow.
I have no way to judge the impact of the specific trades but the scenario is a not uncommon one to varying degrees and certainly played a role in the 1987 stock market crash with the impact of portfolio insurance.
Any time there is extreme price movement in the market those that are short derivative positions that are options or have options like characterstics need to sell (buy) into a declining (rising) market in order to hedge their short positions that are essentially puts (calls), this selling (buying) then can push the market down (up) further triggering more hedging orders and exacerbating the market move.
The phenomenon is well known the author calls it a tsunami of orders, It occurs in "mini" form in markets for various securities and futures particularly at the expiry of options when the underlying is trading very close to a price where there are large holdings of options at the same level (strike price close to market price at option expiry date)