01/25/2021 — A Perpetual Source of Volatility

At around 9:50 CST this morning, financial markets went into a brief, but sharp nosedive. The S&P index lost over 60 points in about fifteen minutes. As usual, the pundits scrambled to come up with explanations for the tumble, and many of them probably contributed to the downdraft. Yes, Biden’s attempts to pass a large stimulus bill will face stiff headwinds especially in light of the pending impeachment attempt. The market sitting near all-time highs in the middle of the pandemic fails to calm already jittery investors, some of whom might be getting pinched by a short squeeze. And sadly, with lives in ruin and employment hard to find, others are blindly chasing a bull market as a last resort to stave off economic ruin.

These factors — and others — played their part in this morning’s mini-panic. However, the result of standard market imperfections such as these don’t tend to send indexes into one-way slides of this magnitude. Overbought markets and budget concerns incite a downward trend mixed in with a bit of sideways trading, not a mad rush for the exit.

The core reason for this morning’s hiccup stems from the failures of many of the largest retail brokers. Charles Schwab and Robinhood reported technical problems, while customers of Merrill Lynch and E-Trade cited abnormalities and difficulty trading around the same time the selloff commenced. Investors may not crack under the pressure of a couple political concerns or a few poor earnings reports, but they will easily unravel if they find themselves locked out of their accounts, unable to trade.

This is not the first time this scenario has played out, nor will it be the last. The inability to avoid systemic platform outages combined with the potential for faulty applications of algorithmic trading will continue to be an economic boogeyman. Decades ago, the advent of electronic trading promised decreased market volatility, delivered through an influx of liquidity. No longer would customers place their orders through expensive, outdated brokerage houses. They now had direct access to stocks, indexes, and derivatives simply by turning on their computer and jumping online.

Now-obvious concerns of too much liquidity in our markets — provided largely by an undereducated trading population — are a topic for another time, but the secondary issue that arose has never been resolved, and may simply prove unresolvable. The shift from in-person, open-outcry trading to a digitized format composed of millions of computer nodes left the majority of our trading volume at perpetual risk of failure. The network could fail, the computer nodes could fail, the system could always be hacked.

The “flash crash” of May 6th, 2010 laid these facts bare. It is one of the best examples of how badly this new system can fail, but it is far from the only one. To their defense, the exchanges first priority will always be to turn a profit for themselves and their investors. If they are operating within regulations, their only motivation for improving the platform is to best serve their customers. As long as customers continue to pour money into the brokerage houses, neither the discount brokers nor the exchanges have incentive enough to rectify the situation. The SEC, hapless as they are, continues to drown in the financial industry’s wake as they have for decades, so it’s a fool’s errand to expect a solution from them.

In reality, there might not be much that can prevent these outages and failures from periodically causing disturbances large and small. Electronic trading continues to grow in size, scope, and sophistication with no signs of abating. Something as simple and unsophisticated as a major power outage threatens to bring the system to its knees without notice. Sure, major investment groups and traders might have auxiliary power at their disposal, but the vast majority of the new (last 20 years) trading populace does not. The electronic trading platforms constantly improve, but that improvement comes with the specter of software bugs and breaks created by flippant programmers raised on an idiotic culture built around the idea of “move fast and break things.” Not exactly the best mantra for the stability and security of the world’s economic safety valves.

Whatever or wherever the answer is to this perpetual source of volatility, it remains crucial to acknowledge these system abnormalities when they occur instead of offloading the responsibility to secondary causes. The stimulus package, the pandemic, the frothy market were all in place long before we hit today’s air pocket. New to the fold was yet another example of technical breakdown. That was the real reason for what happened this morning. We’re lucky the failure was muted.

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Willie Witten

Willie Witten

Writer, thinker, trader, musician, builder and beer aficionado. Find me at williewitten.com, or onespinmusic.com