"If money isn't loosened up, this sucker could go down" - George W. Bush warned in September 2008

Friday, May 7, 2010

Really great links - Computer Trading - Tim Duy (Q1 GDP & Greece)

Streetwise Professor - Computer trading & crash - "This is the kind of automated trading that is problematic because it can create destabilizing positive feedback effects. Synthesizing index puts as portfolio insurance through a dynamic trading strategy means that big price declines triggered more sell orders that arguably exacerbated the price declines which caused additional sales, and so on. Option hedging strategies (e.g., dealers use dynamic hedges to manage the risk of options they’ve traded with customers) can have the same effect.
        Stop orders (which probably contributed to what transpired today) can have a similar effect; price declines (rises) trigger sell (buy) orders that can exacerbate price moves. These kinds of orders are as old as the market.
        Margin-driven trades can do the same: those suffering losses on a price decline (increase) sell (buy) and who cannot come up with the necessary margin sell (buy) to close positions–again, as old as the market.
        Some computerized trading–and I would argue that most algo trading–is very different. It is a negative feedback strategy. That’s what market makers do: they sell into purchases and buy into sales. Much algo trading is effectively automated market making. It is, in effect, the realization of what the great Fisher Black imagined in 1971, when he wrote an article in the Financial Analyst’s Journal titled “Towards a Fully Automated Stock Exchange.” Black envisioned a fully automated specialist that made markets, and thereby stabilized prices. Computerized/algo market making programs based on negative feedback would have bought on today’s decline as Black described. The rapid snap-back is perfectly consistent with that.
        Moral of the story: ignore categorical condemnations of computerized or quantitative trading in the aftermath of today’s events. There’s good, bad, and ugly. Be careful, and try to distinguish them."

Tim Duy - Still Unbalanced - GDP report - "The recent flow of data is interesting to say the least. While headline numbers are generally solid, the underlying story looks shaky. Shaky enough that disinflationary trends remain firmly entrenched in the US, whereas inflationary risks appear to be growing in emerging markets. The former suggests the Fed is set to remain on hold, while the latter will push foreign central banks to tighten. In a perfect world, that combination would put downward pressure on the Dollar and support a shift to a more balanced pattern of growth for both the world in general and the US in particular. Yet we persistently fall short of a perfect world. Will this time be any different? The Greek crisis is saying it won't.
        The Greek crisis. The Greek drama is obviously far from over; it is not clear that the threat of contagion is even significantly reduced, let alone eliminated. Nor would it be until all the PIIGS committed to a growth sapping fiscal stance, which the Greek public are finding hard to accept. That stance, while perhaps necessary, weighs against global growth and tends to strengthen the Dollar, slowing the rebalancing process. Moreover, I find it difficult if not impossible to believe that the impacted nations can adjust without a significant devaluation. Which suggests the Euro has further to fall. But it is reasonable to believe that, given the German weight in the Eurozone, any decline in the Euro would fall short of what is necessary for the PIIGS to fully adjust. Are we really down to just two choice then? Either Northern Europe commits to perpetual fiscal transfers to Southern Europe (not going to happen), or the Eurozone shrinks? Both suggest a weaker Euro, but the latter points to an outright collapse."

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