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The Dow Jones Industrial Average
(INDU) has hit its all-time high, set in 2007. The US stock market has rallied significantly despite the debt ceiling issue and fiscal concerns.
But this five-year stock market ride from 2007 to 2012 has been anything but smooth. Beside the market being cut about half in value through the financial crisis, we have faced a host of macroeconomic shocks.
These include the debt ceiling debates, the housing crash, the fiscal cliff, the Japanese tsunami, the flash crash and the Euro debt crisis. I would point to four factors which I believe created greater instability in the financial markets in recent years.
High Frequency Trading – This age of supercomputers and super quick flash trading has created a few advantages for investors. Online trading is now more cost effective and faster than it has ever been before for investors.
There are some quantitative investors, including hedge fund managers, who create lightning fast trading programs which are designed to exploit market movements that may only last for a fraction of a second. At times, these traders may create more efficiency in the marketplace.
For example, if a stock trades out of whack temporarily with its fundamentals or technicals, these programs may create liquidity by buying back (or selling) the shares within milliseconds. Thus they would push back the shares to a more reasonable (according to a program’s algorithms) price point.
There are however, times when these trading programs could become destabilizing. An example would be if these programs were looking to exploit a selloff or downward momentum in the market. One of the largest quantitative trading hedge funds (
Renaissance Technologies) for example has used a strategy that, in my opinion, seems intuitively destabilizing at times.
I believe these programs are too quick for a human being to effectively control. Consequently, if there are glitches such as the Flash Crash, human beings appear less able to understand and remedy the situation than they have in the past.