High Frequency Trading distorts US markets

S&P vol Dec11.pngThe chemical industry, like many others, continues to be badly affected by the volatility of financial markets. Yesterday (Tuesday), for example, saw a 3% jump in US stock prices and crude oil prices.

The ‘justification’ for the surge was a minor rise in November’s US housing starts to 685k. As the weather has been seasonally mild, this should hardly have been a surprise. And it certainly does not suggest a major recovery is suddenly underway in the housing market. 685k is one of the lowest figures even seen since records began in 1959.

The real reason was the activities of the ‘High Frequency Traders’ (HFT), who now dominate US financial markets with their ‘correlation trading’. EPCA speaker Marc Faber points out in a recent note that:

“It is truly frightening to consider we have already surpassed the previous record of 26 huge downside daily swings in 2008, when the financial system nearly collapsed… never before have we seen a methodology overwhelm the US stock market as HFT has done”.

The chart above, based on Faber’s data, shows how bad things have got. The key is the number of days when virtually the whole market moves one way or another, with volume in a 9:1 ratio up or down.

• 2009, 2010 and 2011 have each seen more high volume Up and Down days than in the whole of the 10 years between 1997-2006
• 1997-2006 saw only 12 Up days of 9:1 volume, and 16 Down days
• 2011 has seen 13 Up and 32 Down (annualised through November)

Prior to HFT, it would take a really major event such as the 9/11 tragedy to move stock and oil markets on such a scale. Normally, some company shares would be up, and some down, as investors responded to recent news. Similarly, oil prices would also move independently, based on their own fundamentals of supply and demand.

But HFT requires vast numbers of shares to be traded by the (mainly) boys with the super-computers. So they jump on any bit of news, no matter how irrelevant, and turn it into a major event. Then next day, they can have more fun by reversing the trend again.

Nobody can plan ahead sensibly with this kind of casino mentality ruling financial markets. No single market now knows what it is pricing, when they all move together like this.

Someday, it will all end in tears. But as long as the regulators remain asleep at the wheel, the HFT traders will party on.

About Paul Hodges

Paul Hodges is Chairman of International eChem, trusted commercial advisers to the global chemical industry. The aim of this blog is to share ideas about the influences that may shape the chemical industry over the next 12 – 18 months. It will try to look behind today’s headlines, to understand what may happen next in important issues such oil prices, economic growth and the environment. We may also have some fun, investigating a few of the more offbeat events that take place from time to time. Please do join me and share your thoughts. Between us, we will hopefully develop useful insights into the key factors that will drive the industry's future performance.

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