Best of the Week
Most Popular
1. The Trump Stock Market Trap May Be Triggered - Barry_M_Ferguson
2.Why are Central Banks Buying Gold and Dumping Dollars? - Richard_Mills
3.US China War - Thucydides Trap and gold - Richard_Mills
4.Gold Price Trend Forcast to End September 2019 - Nadeem_Walayat
5.Money Saving Kids Gardening Growing Giant Sunflowers Summer Fun - Anika_Walayat
6.US Dollar Breakdown Begins, Gold Price to Bolt Higher - Jim_Willie_CB
7.INTEL (INTC) Stock Investing to Profit From AI Machine Learning Boom - Nadeem_Walayat
8.Will Google AI Kill Us? Man vs Machine Intelligence - N_Walayat
9.US Prepares for Currency War with China - Richard_Mills
10.Gold Price Epochal Breakout Will Not Be Negated by a Correction - Clive Maund
Last 7 days
If You Don’t Understand Bonds, You Don’t Understand Investing - 25th Aug 19
Gold's Next Move - 25th Aug 19
Fresh Water Crisis Unfolding - 25th Aug 19
Newbie Guide to Currency Pairs in Forex Trading – Review - 25th Aug 19
When A 16-Year-Old Earns $3 Million, You Know It's Not A 'Silly Fad' - 24th Aug 19
The Central Bank Time Machine - 23rd Aug 19
Stock Market August Breakdown Prediction and Analysis - 23rd Aug 19
U.S. To “Drown The World” In Oil - 23rd Aug 19
Modern Monetary Theory Could Destroy America - 23rd Aug 19
Seven Key Words That Explain "Stupidly High" Bond Market Prices - 23rd Aug 19
Is the Fed Too Late Prevent A US Housing Bear Market? - 23rd Aug 19
Manchester Airport FREE Drop Off Area Service at JetParks 1 - Video - 23rd Aug 19
Gold Price Trend Validation - 22nd Aug 19
Economist Lays Out the Next Step to Wonderland for the Fed - 22nd Aug 19
GCSE Exam Results Day Shock! How to Get 9 A*'s Grade 9's in England and Maths - 22nd Aug 19
KEY WEEK FOR US MARKETS, GOLD, AND OIL - Audio Analysis - 22nd Aug 19
USD/JPY, USD/CHF, GBP/USD Currency Pairs to Watch Prior to FOMC Minutes and Jackson Hole - 22nd Aug 19
Fed Too Late To Prevent US Real Estate Market Crash? - 22nd Aug 19
Retail Sector Isn’t Dead. It’s Growing and Pays 6%+ Dividends - 22nd Aug 19
FREE Access EWI's Financial Market Forecasting Service - 22nd Aug 19
Benefits of Acrobits Softphone - 22nd Aug 19
How to Protect Your Site from Bots & Spam? - 21st Aug 19
Fed Too Late To Prevent A US Housing Market Crash? - 21st Aug 19
Gold and the Cracks in the U.S., Japan and Germany’s Economic Data - 21st Aug 19
The Gold Rush of 2019 - 21st Aug 19
How to Play Interest Rates in US Real Estate - 21st Aug 19
Stocks Likely to Breakout Instead of Gold - 21st Aug 19
Top 6 Tips to Attract Followers On SoundCloud - 21st Aug 19
WAYS TO SECURE YOUR FINANCIAL FUTURE - 21st Aug 19
Holiday Nightmares - Your Caravan is Missing! - 21st Aug 19
UK House Building and House Prices Trend Forecast - 20th Aug 19
The Next Stock Market Breakdown And The Setup - 20th Aug 19
5 Ways to Save by Using a Mortgage Broker - 20th Aug 19
Is This Time Different? Predictive Power of the Yield Curve and Gold - 19th Aug 19
New Dawn for the iGaming Industry in the United States - 19th Aug 19
Gold Set to Correct but Internals Remain Bullish - 19th Aug 19
Stock Market Correction Continues - 19th Aug 19
The Number One Gold Stock Of 2019 - 19th Aug 19
The State of the Financial Union - 18th Aug 19
The Nuts and Bolts: Yield Inversion Says Recession is Coming But it May take 24 months - 18th Aug 19
Markets August 19 Turn Date is Tomorrow – Are You Ready? - 18th Aug 19
JOHNSON AND JOHNSON - JNJ for Life Extension Pharma Stocks Investing - 17th Aug 19
Negative Bond Market Yields Tell A Story Of Shifting Economic Stock Market Leadership - 17th Aug 19
Is Stock Market About to Crash? Three Charts That Suggest It’s Possible - 17th Aug 19
It’s Time For Colombia To Dump The Peso - 17th Aug 19
Gold & Silver Stand Strong amid Stock Volatility & Falling Rates - 16th Aug 19
Gold Mining Stocks Q2’19 Fundamentals - 16th Aug 19
Silver, Transports, and Dow Jones Index At Targets – What Direct Next? - 16th Aug 19
When the US Bond Market Bubble Blows Up! - 16th Aug 19
Dark days are closing in on Apple - 16th Aug 19
Precious Metals Gone Wild! Reaching Initial Targets – Now What’s Next - 16th Aug 19
US Government Is Beholden To The Fed; And Vice-Versa - 15th Aug 19
GBP vs USD Forex Pair Swings Into Focus Amid Brexit Chaos - 15th Aug 19
US Negative Interest Rates Go Mainstream - With Some Glaring Omissions - 15th Aug 19
GOLD BULL RUN TREND ANALYSIS - 15th Aug 19
US Stock Market Could Fall 12% to 25% - 15th Aug 19
A Level Exam Results School Live Reaction Shock 2019! - 15th Aug 19
It's Time to Get Serious about Silver - 15th Aug 19
The EagleFX Beginners Guide – Financial Markets - 15th Aug 19

Market Oracle FREE Newsletter

Top AI Stocks Investing to Profit from the Machine Intelligence Mega-trend

The Dangers of Quant Computer Trading Models, Dow's 1000 Point Drop Prime Example

Stock-Markets / Financial Crash May 10, 2010 - 10:45 AM GMT

By: Sol_Palha

Stock-Markets

Best Financial Markets Analysis Article"Build a system that even a fool can use, and only a fool will want to use it." ~ George Bernard Shaw, 1856-1950, Irish-born British Dramatist

The initial trigger for the drop in the Dow was probably due to fears that the Greek crisis was going to spread. One could credit this for 300 or maybe even a 400 point drop in the Dow; however, a 1000 point drop is quite another matter.


At 2.20Pm the Dow was at 10,460 and then suddenly in 7 minutes it shed another 600 points. Humans could never move that fast. There are rumours that a trader entered billion instead of million and this triggered the massive sell off. Whatever the cause the main wave of selling was initiated by computers.

A simplified look at quant models

A Quant (Quantitative) programme is a computer model which determines which investment strategy is going to yield a superior rate of return; to simplify matters let's assume the programme decides when to go long or short.. It is assumed that because computers have no emotions, they should be better at trading as they can move in and out of the markets extremely rapidly. The scary part is that the computer renders the final decision. There is one problem, these computers are programmed by humans and one glitch in the programme can cause havoc. Let's not forget the old saying junk in junk out. Today's wild action is indicative of what can go wrong when computers take over.

These quant programs now make the vital function of market marker almost obsolete and this is a very dangerous situation if left unchecked. Today Treasuries, SP500 and other indices were moving so fast it was hard to manually follow them. Computers took over the markets for a few minutes and in that time they wrecked total havoc. What happens if the glitch is not spotted immediately, then a cascade of sell orders could be triggered pushing the Dow down until the circuit breakers kick in. However, if the glitch was not found then computers would resume selling after the markets opened again. Let's not forget that big firms can still sell via Dark pools. They are basically electronic networks that allow big firms to sell stocks without tipping their hand; in other words, they can sell these stocks anonymously without the public ever knowing. This is a separate topic, and we will try to cover it another day. Two examples of firms offering such services are Liquid net Inc., Pipeline.

Quant strategies are becoming extremely popular. They are now accepted in the investment community and even mutual funds are now using these models. These models are also known as alpha generators, or alpha gens. These programs are often set up in advance so that the computer can react instantaneously to moves in the market. For example, if the Dow drops below a certain level, the programme can unleash a massive sum of sell orders and in doing so trigger other quant programs. This could potentially trigger a market meltdown as was experienced today. Indeed by some counts computers are responsible for as much as 70% of daily trading volume.

These models are now a real threat to the health of the financial markets and should be eliminated or closely monitored and regulated. Exchanges should not cater to firms that are using these programs and openly allow computers to place orders for millions and or billions of dollars. Exchanges should place a dollar limit on trades that can be initiated by such programs. One can only imagine what would happen if the computer mistakenly places a trillion dollar sell order. Today's action is a warning, next time things could be infinitely worse. At one point ACN fell from 42.30 to 4 cents, that is 4 cents; it ended the day at 41.08 down $1.08. PHO dropped from $18 to 10 cents in a matter of minutes. PG shed $23 dollars in a heartbeat but closed the day down only $1.41. In between someone could have had a heart attack. Imagine you had 1 million dollars in ACN, and then suddenly watched your portfolio shrivel right in front of your eyes as ACN fell to 4 cents from 42 dollars.

One of our first warnings came from Long term capital (LTC). LTC founded in 1994 was one of the most famous Quant based funds and it was run by two noble prize winning economists: The Quant model did not foresee the Russian government defaulting on its own debt and this triggered a series of events that destroyed LTC. In less than 4 months in 1998 LTC lost 4.6 billion dollars. If the Feds had not stepped in, things could have really turned ugly.

These quant trading programs need to be regulated and not allowed to freely take over the markets; they are destroying the vital role market makers play to maintain financial stability in the markets. Today's action should serve as a wake up call for those who have turned a blind eye to risks these programs pose to the markets. Next time round we might not be so lucky.

On a separate note we warned individuals about the dangers poised by the extremely low volume in an article that was just published one day before the event Precipitously Low Market Volume a Sign That Correction Is Imminent

Conclusion

As Jim Rogers puts it "the NYSE should be hanged" and we agree wholeheartedly. Not only should they be hanged but a 1 billion dollar fine should be imposed on whoever was responsible for this problem. Officials are stating that they will only cancel trades where the loss was 60% or more, well what about all the others who lost in between 20-60%. The greedy bankers get to buy all those shares at a huge discount and lock in huge profits at the expense of the regular investors. Outright fraud like this has to be stopped; stiff fines should be imposed on the perpetrators and the SEC should finally start doing the job its getting paid for.

"The key to the age may be this, or that, or the other, as the young orators describe; the key to all ages is -- Imbecility; imbecility in the vast majority of men, at all times, and, even in heroes, in all but certain eminent moments; victims of gravity, custom, and fear." ~ Ralph Waldo Emerson, 1803-1882, American Poet, Essayist

by Sol Palha

www.tacticalinvestor.com

Sol Palha is a market analyst and educator who uses Mass Psychology, Technical Analysis and Esoteric Cycles to keep you on the right side of the market. He and his partners are on the web at www.tacticalinvestor.com.

© 2010 Copyright Sol Palha   - All Rights Reserved

Disclaimer: The above is a matter of opinion provided for general information purposes only and is not intended as investment advice. Information and analysis above are derived from sources and utilising methods believed to be reliable, but we cannot accept responsibility for any losses you may incur as a result of this analysis. Individuals should consult with their personal financial advisors.


© 2005-2019 http://www.MarketOracle.co.uk - The Market Oracle is a FREE Daily Financial Markets Analysis & Forecasting online publication.


Post Comment

Only logged in users are allowed to post comments. Register/ Log in

6 Critical Money Making Rules