In 2009 I sent out a newsletter with the following quote: “I have never seen this kind of volatility or irrational activity in 20 plus years." I later went on to mention the "...large one day drop of 4.58%..." My how times have changed, or not!
My first comment certainly holds true today. The daily volatility, which I address below, would have been unthinkable just two or three years ago. And while I do not mean to minimize the seriousness of the corona virus, I cannot call the market reaction rational.
This article is intended to address some of the volatility experienced over the last couple of weeks.
The combination of indexing and quantitative algorithmic trading has created a situation of tremendous volatility. When indexers sell, they're not just selling overpriced stocks, they're selling everything in the index, indiscriminately. This has profound implications on the levels of broad market volatility, as we've been witnessing, exacerbated by the quants and their computer-based AI programming (the 'bots) that pay little attention to fundamental analysis.
There is a statement often made by individuals about the market. "For every buyer, there is a seller." The belief has always been that if an individual wants to sell, there will always be a buyer available to execute the transaction at any given price. However, such is not actually the case. The correct statement is: "For every buyer, there is a seller...at a specific price." In other words, when the selling begins, those wanting to "sell" overrun those willing to "buy," so prices have to drop until a "buyer" is willing to execute a trade.
With the concentration of risk, lack of liquidity, and a market increasingly driven by "robot trading algorithms," reversals are no longer a slow and methodical process, but rather a stampede with little regard to price, valuation, or fundamental measures.
We would expect this volatility to continue for some time. Recently, futures indicated the Dow Jones Industrial Average would open 400 points lower, and the following morning the Dow Jones Industrial Average has opened about 800 points higher. That's not "Mom and Pop" investors selling overnight and buying at the breakfast table.
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