Wall Street & Technology is part of the Informa Tech Division of Informa PLC

This site is operated by a business or businesses owned by Informa PLC and all copyright resides with them. Informa PLC's registered office is 5 Howick Place, London SW1P 1WG. Registered in England and Wales. Number 8860726.

Infrastructure

12:34 PM
Matt Samelson
Matt Samelson
Commentary
Connect Directly
Twitter
RSS
E-Mail
50%
50%

Global Market Volatility Comes as No Surprise

Most conversations about the financial markets last week centered largely on the "extreme" market activity taking place.

Most conversations about the financial markets last week centered largely on the "extreme" market activity taking place. "Experts" everywhere were completely surprised, suggesting the market behavior was caused by everything from credit downgrades to aliens (well, almost). We at Woodbine Associates are amazed that so many savvy market professionals and observers have been so taken aback by this activity; we are also unimpressed by the widely divergent range of explanations and analysis, most of which miss the point.

We have said it before and shall say it again: the current market activity is an expected, short-term aspect of the market structure we have created through regulation and technology.

We have seen last week's global market rollercoaster before. The good news is it follows a clearly discernible pattern of event types observed on May 6, 2010 and during other recent periods of significant directional movement and volatility.

How These Seemingly "Extreme" Periods Are Triggered In US Equity Markets:

  • One or more significant, fundamental, economic event triggers a large scale buy-sell imbalance among instruments in one market.
  • The buy-sell imbalance pushes prices downward.
  • Market mechanics kick in:
    • Liquidity takers begin to "walk the book." Stop-limit orders execute. Orders with limits away from the prevailing quote under normal conditions are triggered. Algorithms kick in, amplifying the directional movement.
    • The security becomes over-sold. At some point, short-covering begins. More algorithms are triggered. High frequency strategies designed to identify mis-pricing are initiated. These activities stem, and eventually reverse, the market directional movement.
    • The direction of price movement is reversed. However, momentum largely created by automated trading activities pushes price past fair value in the opposite direction, toward the upside, until an overbought condition is created. Similar activities that reversed the precipitous fall in prices reverse the upward movement in prices.
    • The cycle continues, amplified by fear, uncertainty, and retail investment flows. It spreads across markets and geographies, where that fear, uncertainty, and speculation may cause unexpected movements in those markets. This, in turn, can perpetuate or amplify the activity in other markets.

This chain of events should not surprise anyone. It is the "price" we pay for tighter spreads, lower latency, better executions, more liquidity, and lower volatility during "normal" market periods.

Let's look closer at what happened last week.

Matt Samelson is a Principal at Woodbine Associates, Inc. focusing on strategic, business, regulatory, market structure and technology issues that impact firms active in and supporting the global equity markets. He brings to the firm a wealth of experience in U.S. and ... View Full Bio
Previous
1 of 3
Next
More Commentary
A Wild Ride Comes to an End
Covering the financial services technology space for the past 15 years has been a thrilling ride with many ups as downs.
The End of an Era: Farewell to an Icon
After more than two decades of writing for Wall Street & Technology, I am leaving the media brand. It's time to reflect on our mutual history and the road ahead.
Beyond Bitcoin: Why Counterparty Has Won Support From Overstock's Chairman
The combined excitement over the currency and the Blockchain has kept the market capitalization above $4 billion for more than a year. This has attracted both imitators and innovators.
Asset Managers Set Sights on Defragmenting Back-Office Data
Defragmenting back-office data and technology will be a top focus for asset managers in 2015.
4 Mobile Security Predictions for 2015
As we look ahead, mobility is the perfect breeding ground for attacks in 2015.
Register for Wall Street & Technology Newsletters
Video
7 Unusual Behaviors That Indicate Security Breaches
7 Unusual Behaviors That Indicate Security Breaches
Breaches create outliers. Identifying anomalous activity can help keep firms in compliance and out of the headlines.