Machines a top suspect in market mayhem
Algorithms may have fuelled U.S. rapid meltdown, but their effect in Canada is less clear
High speed automated stock trading is being implicated in the extreme market volatility on U.S. benchmark indexes this week, but in Canada the impacts are harder to discern.
“It’s certainly true that when you’ve got things moving faster there is more potential for a sell-off and a bounceback,” said Richard Carleton, CEO of Toronto-based alternative bourse the Canadian Securities Exchange.
But Carleton also noted that stock trad- ing in general has become digital, with individual investors able to buy and sell securities over electronic networks. He added that so-called high-frequency trading, or HFT, where market orders can be processed in milliseconds is just one of many factors playing into the volatility.
In the U.S., however, Treasury Secretary Steven Mnuchin told the House Financial Services Committee members this week that algorithmic trading, which uses automated pre-programmed instructions to execute large orders based on certain triggers, “definitely had an impact” during Monday’s market meltdown.
That’s when the blue-chip Dow Jones industrial average index fell nearly 1,600 points at its low point before closing down by 1,175 points to register its worstever single-day drop in terms of points.
Algorithmic trading applies computer programs to execute orders with instructions accounting for variables such as time, price and volume to send a small part of an order over time, which can mute the impact of a single big trade and minimize the cost and risk of the transaction.
But Jos Schmitt, CEO of the Aequitas NEO Exchange, also in Toronto, said such trades can also amplify market moves that are initially spurred by investor sentiment, with the fallout showing up in macro-market “flash” crashes and other erratic patterns.
Schmitt, who said HFT makes up as much as 50 per cent of overall stock trade volume in Canada, said the NEO exchange has taken steps to prevent automated predatory market behaviours “that others embrace,” with high-speed, high-volume electronic trading making up only about 5 per cent of the overall NEO volume.
He said the vast majority of new exchanges such as the CSE and NEO that provide alternatives to more traditional bourses are driven by highfrequency firms, with incumbents such as the S&P/TSX composite index left with little choice but to adopt high-frequency trading platforms to remain competitive.
Schmitt added that the capacity to trade at blinding speeds lends an edge to high-volume institutional traders over individual investors, suggesting that the technology needs to function on a level playing field and that regulators should require greater disclosure by exchanges on the prevalence of high-frequency trading activities.
Schmitt called the lack of market data disclosure in Canada “mind boggling.”
TMX Group, which operates exchanges including the S&P/TSX, says it has “no definitive evidence” that would lead it to attribute recent volatility to its market ecosystem, which includes electronic engines that can process billions of trade execution messages in a single day.
Moreover, self-regulatory agency the Investment Industry Regulatory Organization of Canada (IIROC) says it continues to support the conclusions of its 2015 report that found HFT trading may provide a net benefit to market function in that it can support liquidity and militate against risk.
Mostly used by institutional investors, such trading accounts for as much as 60 per cent of all activity in U.S. markets versus traditional stock picking, according to research last year. Black-box trading, which uses speed to beat rivals to profits, has been shown in research to hasten and deepen market moves initiated by macro factors such as concerns over rising borrowing costs.
The lightning-fast Dow meltdown about an hour before the close of trading Feb. 5 seems to have the hallmarks of a black box move, suggested Walter Hellwig of Alabama-based BB&T Wealth Management.
Volatility on the S&P/TSX, meanwhile, triggered an unusually high volume of single-stock circuit breakers, which automatically halt trading in an individual security for a brief period when its price moves up or down beyond a specified threshold, said IIROC spokesperson Andrea Zviedris. She said she had no information showing whether trades were executed using algorithmic programs. The S&P/TSX shed more than 500 points over trading on Feb. 5 and the previous Friday while the Dow dropped in excess of 1,660 over the same period, including a tumble of more than 800 points in less than 15 minutes on Monday. With files from Bloomberg