Saturday, March 28, 2020

Algorithmic stock trading is annoying but doesn't call for for machine breaking

I'm not a big financial guy but, like may others, I have been glumly tracking our investment portfolio - our retirement fund - in its inexorable downward spiral throughout the COVID-19 outbreak.
It does seem to be the case that the stock markets are more volatile than they used to be. When things go wrong, they go very wrong, and simularly, during the good times, the markets tend to react excessively (which is not such a big problem, but it's still a problem).
One reason for this increased votality is the advent of computerized, or algorithmic, trading. Thousands of computers initiate and execute stock market trades automatically, based on preprogrammed algorithms that follow market changes on a second-by-second (or even micro-second) basis. High-frequency algorithmic trading is an even more extreme version, where compters place thousands of orders at blindingly fast speeds, looking to cash in on many, many tiny individual profits.
This is much quicker, cheaper and more reliable/consistent than human trading. But, despite advances in AI, it lacks the subtlety, imagination and lateral thinking of human involvement. It also lacks a sense of perspective and restraint, and when the markets are falling, as they have been recently, computerized trading will tend to exaggereate and exacerbate the downward trend.
Given that anywhere from 60% to 80% of trading is now algorithm-based, the effects of algorithmic trading are huge, and the markets can swing wildly as a result. In technical jargon, it amplifies systemic risks, and it increases uncertaintly in already uncertain times. It can also react mindlessly to fake orders, or"spoofing", and sometimes algorithms can, and do, go wrong, which can lead to large errors in stock pricing.
Of course, the flip side is that, in a bull market, computers exaggerate trends in the other direction, although we tend not to complain about it then. So, we end up with an unnecessarily exaggerated roller-coaster ride of a stock market.
And what is my point in making these observations? Nothing really. I'm not proposing a Luddite-style machine-breaking. Not just yet. Our investments are (mainly) long-term, and the market will come back up again eventually. But is a bit annoying that when we have to liquidate funds for spending money, stock prices may be unnecesarily depressed because of a load of unimaginative computers.

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