• 8 hours The Surprising Businesses Deemed “Essential” During The Coronavirus Lockdown
  • 12 hours Priceless Van Gogh "Spring Garden" Painting Stolen
  • 14 hours Oil Falls To $20 For First Time In Nearly Two Decades
  • 16 hours COVID-19 Could Be The End Of U.S. Coal
  • 1 day How Much Does Your Social Security Number Cost? $4 On The Dark Web
  • 3 days Silver Stocks Have Been Decimated In The Coronavirus Sell-Off
  • 3 days How Blockchain Tech Could Make Mergers And Acquisitions More Efficient
  • 4 days America’s Shortage Of This Metal Keeps Trump Up At Night
  • 4 days Bidet Bonanza: Defying The Toilet Paper Shortage
  • 5 days U.S. Auto Sales Fall By 75%
  • 5 days Violating Quarantine? Big Brother Is Watching
  • 6 days Does Gold Still Have Some Room To Run?
  • 6 days Major Acquisition Gives The World’s First Green Ride-Share Another Edge
  • 6 days U.S. Pushes For Digital Currency For Immediate Stimulus
  • 7 days The Impossible Challenges Created By Growing Population
  • 7 days Gold Skyrockets After Fed Pledges "Unlimited" Cash To Boost Economy
  • 7 days World’s Richest Lose $1 Trillion In Stock Market Rout
  • 8 days Gas Stations Shut Down In Venezuela As Coronavirus Crisis Intensifies
  • 8 days The Best And Worse Case Scenario For The U.S. Stock Market
  • 8 days 3 Industries Soaring During The Coronavirus Crisis
What's Behind The Global EV Sales Slowdown?

What's Behind The Global EV Sales Slowdown?

An economic slowdown in many…

How The Ultra-Wealthy Are Using Art To Dodge Taxes

How The Ultra-Wealthy Are Using Art To Dodge Taxes

More freeports open around the…

  1. Home
  2. Markets
  3. Other

Goldman: Machines Are Taking Over Markets

Robot

 “Liquidity is the new leverage”: That was the ominous warning fired by Goldman Sachs’ head of Global Credit Strategy, Charles Himmelberg, admonishing traders about the dangers of the ongoing algorithmic transformation in the markets, including the toxic combination of Quant Funds and High-Frequency Trading and how they put the bond and equities markets at high risk of a systemic event.

What he meant was this: The heavy use of leverage has historically been responsible for most market crashes, but right now it's liquidity—or, more specifically, the lack of it--that's likely to be their undoing.

But how does that work?

HFT traders and quant funds are likely to withdraw liquidity from the market during periods of market stress when, ironically, it's needed the most.

As machines continue taking over trading roles in the market, the inability of human market liquidity providers to process complex information as quickly as their computer counterparts might lead to large drops in liquidity that could precipitate a market crash.

Machines Take Over the Markets

This was not the first time that the Wall Street analyst has chimed in heavily on the subject. In fact, he’s done so repeatedly since the February 5 market crash.

 And just as well, because robots have truly taken over equities trading.

JPMorgan estimates that passive and quantitative trading now account for 60 percent of all equities trading, double from a decade ago. Meanwhile, human discretionary investing accounts for a mere 10 percent of trading volume.

Quantitative trading is a complex type of trade encompassing high-frequency trading, algorithmic trading and statistical arbitrage using a combination of sophisticated statistical models, fiendish mathematical models and computer modeling to automate the process of monitoring markets and making trades entirely using robots.

(Click to enlarge)

Source: Bloomberg

Robots Wreak Havoc

This is not mere babbling by an armchair analyst but serious stuff by a non-tinfoil hat-wearing Goldmanite.

There's ample evidence that HFT and QT are to blame for some of the most memorable flash crashes. The most recent flash crash of February 5 was pinned on robots and the role of high-risk volatility instruments which Credit Suisse, the issuer, thankfully banned. Others include the Peet's Coffee and Tea incident of 2012, the Knight Capital sell-off and the 2010 flash crash. Related: What $250k Buys You Across The U.S.

Goldman offers compelling validation. The image below shows how HFTs behave around major world news events. The right chart shows how HFTs' participation rate drops from 50 percent about 10 minutes before the announcement to 33 percent at the time of release. The chart on the left shows how overall market depth declines sharply around the time of news release.

(Click to enlarge)

Source: Zero Hedge

This HFT reluctance to provide market liquidity is what Goldman is talking about. HFTs tend to pull back whenever they realize that fundamental information entering the market is likely to give human traders an advantage.

Himmelberg offers two key pieces of advice to traders to avoid finding themselves on the wrong side of these HFT trades:

• Avoid being lulled into a sense of complacency even during times of macroeconomic stability.

• Carefully consider the quality of trading liquidity even for the most-heavily traded markets. Consider 'vol of vol' when hedging market risk and don't be fooled by fat tails.

And that puts paid the common belief that there's copious liquidity parked across all asset classes.

By Alex Kimani for Safehaven.com

More Top Reads From Safehaven.com

Back to homepage

Leave a comment

Leave a comment