"When in doubt blame it on the computers."
Nowadays, this seems to be the go to scapegoat for any market related problems. Over the last few days, numerous reports have said it is the computers to blame for the whipsaw trading the market has seen in recent weeks.
The explanation sounds plausible, but it is not necessarily borne out by the facts. Over the last 50 trading days, the average daily percentage move (up or down) in the DJIA has been 0.90%. Relative to history, the current level is far from the extreme readings we saw during the Financial crisis when the average daily change rose to 3.71%. Granted, the last few days have been extremely volatile, so if the recent trend continues, we will see the current 50-day average rise much higher.
One could still argue that computers were behind the big spike in volatility during the Financial Crisis, but what would explain the big spike in the 1930s, when the average daily change was also above 3%? Last we checked, there were no computers back then. While HFT and computer trading may be contributing to the recent surge in volatility, it isn't solely to blame. The reality is that when the market goes down, investors step to the sidelines, causing liquidity to dry up. In illiquid markets, price volatility rises.Click to enlarge