Could HFT Hedge Funds Spark a New Flash Crash?

Ask any parent of a five year-old about their child's soccer game and they all describe the same strategy: Every kid chases the ball. Sure, it's adorable and there might be a long nap after the ice cream but it's not really a game when everyone has the same tactic.

This is happening inside today's hedge funds. High-frequency trading firms were a rarity until they started racking up big profits. Now, nearly every hedge fund has a quant or two to write formulas that will beat the competition. They're also using historical market data from data providers to look back to prices and trading cycles in the 1990s and 1980s. One data vendor told me that some firms want data going back to the Civil War.

Hmm, what was the price of cotton on Juneteenth 1865?

What could go wrong? In a special report, Reuters looks at how HFT is becoming routine and potentially dangerous. Money graffs:

One problem is that most firms use similar data. Good, computer-ready historical price information only goes back to the 1970s or '80s and some CTAs focus on this because they believe the rise of computer trading makes price movements in older markets irrelevant today.

The risk is obvious. Funds might all follow the same trend, and "something happens which forces a reversal in that trend," said Alex Allen, Senior Portfolio Manager at London-based Sciens Capital, which invests in hedge funds including CTAs.

Think of it as a slow-motion flash crash.

"It's hugely risky," says UCL's Treleaven. Imagine, "everything is going fine and they are all trading fine and then you go through some particular event and all the funds lock onto it, and they all go down together."

Sometimes you have to take your eye off the ball to make sure you and everyone else aren't heading over a cliff.