Estimates vary, but HFT black-box computer trades may account for 50% of all stock market trades, and they were a significant factor in crashes as old as 1987 to as recent as 2010’s flash crash. They are designed to act in the market before humans can, and hence their collective action can at times compound and trigger very fast, large price moves. Circuit breakers are now in place on the stock indices, designed to close the market for anything from 15 mins to the rest of the day, depending on the depth of the declines. They don’t prevent further selling once the market re-opens – they are designed to give time to reconsider, but the predominance of crash days on Mondays suggests time to reflect may in fact increase fear.
The May 2010 flash crash was initiated with a large sell order set against an almost complete absence of buyer orders, then multiple and successive trigger sells. The algorithms used in computer trading vary, but they include mean reversion strategies, trend following and stop-losses. Recently we have built up a significant range of extremes from means, including sentiment, valuations, leverage, distance above moving average and time without a significant correction. Thursday and Friday last week provided price action to break the uptrends in multiple indices and stocks.
Here is a compilation of indicators that reveals the same signals are in place now as were at the May 2010 flash crash. Click to view larger.
The backdrop now mirrors the 2010 crash backdrop, only this time round we reached greater extremes in all seven indicators. This suggests another crash is probable, and the depth of the crash likely to be larger. Drawing on those historic topping process parallels, it is possible buyers and buy programmes re-emerge this next week and it is still a bull-bear battle, but with a downward bias, pushing true market crash action out into February, March or even April. However, Friday’s one-sided price action together with the predominance of historic Monday crashes and the mirror backdrop to May 2010 (only more extreme in all signals) gave me a sense of urgency about putting this out today.