Don’t Blame The Algorithms For The Market Crash?

Don’t Blame The Algorithms For The Market Crash?
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No, don’t blame the algorithms, says Ralf Roth, chief executive officer at Quantitative Brokers. Causation for the market crash was first due to a fundamental concern followed by logical if-then events that resulted in a leveraged volatility train wreck that should have been expected.  On January 31, the company announced a partnership to offer a trade simulation tool through the Bloomberg Terminal that might be getting a work out during this market environment.

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What started this market price volatility was not an algorithm, Roth said. It was a concern over rising interest rates – the withdrawal of quantitative stimulation – as causation for Friday’s nearly 600-point drop in the Dow Jones Industrial Average. This move has triggered a chain reaction that has extended to Thursday, a day when the Bank of England has indicated that it, too, is another central bank turning hawkish.

Roth says it was a fundamental concern over interest rates that triggered the initial sharp price move, which resulted in volatility triggers in systematic investment programs selling. While this was a factor, the largest issue in the market sell-off was not due to algorithms, but rather the highly leveraged volatility trading products that caused a correlation breakdown, he said.

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“This wasn’t a real market crash,” Roth told ValueWalk Wednesday, pointing to extremely odd price correlations between the VIX and its underlying contract, the S&P 500, as being a meaningful point of market distortion. “Clearly there was a disconnect between what was happening in the stock market and its related volatility.”

But how did this occur?

While Treasury Secretary Steven Mnuchin said that algorithms “definitely had an impact” in Monday’s 1,175-point drop in the Dow he could not have been referring to what Roth said was the core fundamental performance driver of interest rate hikes. Assuming that Roth is correct, concern over interest rate hikes isn’t something algorithms directly are known to recognize. What happened on Monday was a reaction to fundamental news by volatility-triggered funds, Roth says.

He says the VIX futures are not the problem, but rather the “double, triple and even quadruple leveraged short volatility funds that finally puked blood as had been widely anticipated by professional traders." A recent Bank of America Merrill Lynch fund manager study, for instance, pointed to short volatility as the market’s most crowded trade.

“Clearly have been questions around highly leveraged volatility,” he said. “Not VIX futures, which are a solid instrument that people use to buy or sell volatility.” What really mattered was the leveraged short volatility trade. “That could be the straw that broke the camel’s back.”

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Mark Melin is an alternative investment practitioner whose specialty is recognizing a trading program’s strategy and mapping it to a market environment and performance driver. He provides analysis of managed futures investment performance and commentary regarding related managed futures market environment. A portfolio and industry consultant, he was an adjunct instructor in managed futures at Northwestern University / Chicago and has written or edited three books, including High Performance Managed Futures (Wiley 2010) and The Chicago Board of Trade’s Handbook of Futures and Options (McGraw-Hill 2008). Mark was director of the managed futures division at Alaron Trading until they were acquired by Peregrine Financial Group in 2009, where he was a registered associated person (National Futures Association NFA ID#: 0348336). Mark has also worked as a Commodity Trading Advisor himself, trading a short volatility options portfolio across the yield curve, and was an independent consultant to various broker dealers and futures exchanges, including OneChicago, the single stock futures exchange, and the Chicago Board of Trade. He is also Editor, Opalesque Futures Intelligence and Editor, Opalesque Futures Strategies. - Contact: Mmelin(at)

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