University of Houston Finance Professor Craig Pirrong rejected current conjecture that recent market sell-offs are due to technology, such as automated, algorithmic or high-frequency trading.
In a recent blog post, Professor Pirrong addressed concerns that increasing automation is responsible for a lack of liquidity during downturns, stating "by virtually every measure, the increasing automation in markets has led to greater liquidity." Moreover, he asserted that the fact that market makers pull back from supplying liquidity during downturns is not unique to HFT; according to Professor Pirrong, this occurred in similar downturns "long before markets went electronic." The same is true for so-called "momentum trading," which Professor Pirrong said "is something else that long predates the rise of the machines."
Because stock market movements are often unexplainable, large moves of an adverse nature often result in a "search for villains and scapegoats," an exercise that, according to Professor Pirrong, is fruitless. He further noted that:
"[t]he bottom line is that the stock market sometimes decline substantially, without any obvious cause. Indeed, the cause(s) of some of the biggest, fastest drops remain elusive decades after they occurred. This is true across virtually every institutional and technological trading environment, making it less likely that any particular selloff is uniquely attributable to a change in technology. Furthermore, large market moves in the absence of any decisive event or piece of news is not inconsistent with market "rationality", or due to some behavioral anomaly (which is inherently human, by the way)."
Commentary / Bob Zwirb
When it comes to the stock market, a little humility goes a long way, if for no other reason than the fact that the market discounts the future, while humans have a hard enough time trying to explain the present or even the past. Thirty years ago, the scapegoat for the 1987 stock market crash was another form of computerized trading called "program trading," which led to calls for further regulation of such trading, as this editorial in Regulation Magazine at the time describes. Indeed, that editorial observed that most of the proposals for dealing with the 1987 crash were "premised on the notion that the crash was caused, either directly or indirectly, by stock index futures and options-instruments . . . exacerbated by huge computer-directed trades." As was the case back then, there is every reason to believe that the downturn today, and the magnitude of the downturn, would have occurred even if stock market derivatives and automated trading strategies did not exist.
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