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Stock Market Plunge And High Frequency Trading

Yesterday's stock market plunge is still being investigated, although a likely cause, or at least a main contributor, appears to be High Frequency Trading.

According to a story in today's Wall Street Journal titled "Did Shutdowns Make Plunge Worse":

"Thursday's downdraft suggests how important that liquidity-providing role has become. Market participants say some high-frequency firms pulled back as the speed and extent of the decline went outside their models, which are generally based on the market behaving in a normal fashion. To avoid the risk of big losses, the firms essentially turned off their trading programs."

I recently (April 8) wrote about my concerns over High Frequency Trading, in which I stated:
"I think that perhaps the most foremost risk, and one that generally receives little heed, is the nature of the (vast) majority of these trades.  These trades don't reflect beliefs about the markets or economy; instead, they seek to profit based upon arbitrage opportunites, spreads, and related issues.  In my opinion, this presents many hazards; perhaps chief among these is that should these arbitrage opportunities, spreads, etc. no longer yield consistent (and/or predictable) profits, there could be a high-speed mass exodus from the markets, creating a liquidity void, i.e. crash.

While markets have always been susceptible to crashes, this High-Frequency Trading, based upon generally unknown factors and concentrated among a small percentage of firms, seems to definitely be a potential problem area."
Underscoring the severity of yesterday's chaos, eight large, liquid stocks, including Accenture, temporarily plunged to a penny a share.  This type of activity is very significant, in my opinion - and it leads one to wonder what type of dynamics can lead to such a compromise of the trading environment.

In conclusion, I wouldn't dismiss yesterday's stock market plunge as a one-off event that is insignificant.

disclosure: no positions



Disclosure: No securities mentioned