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Kill the Quants Before They Kill Us

This commentary originally appeared on Real Money Pro on Aug. 24 at 9:30 a.m. EDT.

Here we go again.

Those quantitative, high-frequency traders that utilize computer programs to focus on price-momentum-based trading "strategies" and the uber leveraged ETFs have retaken control of the wheel.

Neither strategies nor vehicles have any redeeming social and/or economic value. Indeed, one can argue that their influence on the market's volatility is contributing to the negative feedback loop that is threatening our domestic economy's growth trajectory.

They were back in force on Tuesday afternoon, when the DJIA advanced sharply from being up by about 150 points at midafternoon to closing with a gain of over 300 points by day's-end.

Computers don't sleep, don't get tired, don't care about politics or fundamentals and don't vacation in late August in the Hamptons or on the Jersey Shore -- they just wreak havoc on our marketplace by amplifying moves on the downside and on the upside (as they did in the last hour of trading yesterday).

Over the last two hours of trading yesterday, I polled numerous sell-side institutional desks and a number of sizeable high-net-worth brokers, and none of them had any meaningful individual buy orders during the late afternoon that could account for the sharp market advance. By contrast, my contacts in the high-frequency-trading community were on trading overload after 2:00 p.m. EDT, as the quants dominated the market's trading activity (almost all on the "buy side").

Two days ago, in "The Selling Storm Might Be Clearing," although I recognized the important fundamental catalysts of the recent market swoon, the growing ambiguity of worldwide economic growth, the negative feedback loop engendered by the gridlock and rancor associated with the political circus in Washington, D.C., and the fragility of the European banking industry, I also underscored that several non-economic, temporary and artificial influences have conspired to exaggerate high-frequency trading's dominance and impact in accelerating market moves and volatility.

Ever since the investment shock of 2008-2009, some of those non-economic factors, including a general de-risking in the hedge fund industry, growing hedge fund redemptions and a record level of domestic equity mutual fund liquidations, have served to reduce the role of the more stable classes of intermediate- to longer- term investors. This has created a vacuum of the more stable and two-sided retail and institutional trading flows and activity and has produced heightened volatility and a risk-on/risk-off atmosphere (which changes daily) owing to the increased presence and disproportionate role of high-frequency, momentum-based trading strategies. Some have estimated that high-frequency trading now accounts for about three-quarters of all trading!

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