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Why the markets are moving so wildly

The stock market’s recent struggles shouldn’t come as too much of a surprise.

James Moore
Wednesday 26 August 2015 12:14 BST
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A view through smog over the 02 Arena and the Canary Wharf financial district in London.
A view through smog over the 02 Arena and the Canary Wharf financial district in London.

“Sell in May go away, buy again on St Leger Day” runs the old City saying, largely because share prices supposedly drift lower over the summer when much of London’s financial centre is away on holiday.

So perhaps the stock market’s recent struggles shouldn’t come as too much of a surprise. Nonetheless the scale of the violent lurch in the Dow on Monday came as a shock. It lost 1000 points in a matter of minutes, only to recover much of the ground it had lost by lunchtime.

But should this have come as a real surprise?

Traditionally trading volumes in August have been low, and that means that it doesn’t take as much to move markets one way or the other as it does when trading is more active.

The same principle can be seen in horse racing: It might take bets of thousands or even tens of thousands of pounds to move the price of the favourite in a race like the Derby or the Grand National. But bookmakers will react swiftly if you put as little as a few hundred quid on the favourite in a seller on the all weather at Lingfield Park on a wet Wednesday in November.

Now August isn’t usually renowned as a month for big crashes. They’re more common in September and October when the big decision makers are at their desks.

But the point is that those big human decision makers have far less power over the markets than they once did because of the increasing importance of the so called “black box”.

These are computers driven by sophisticated algorithms, that move with extraordinary speed in response to electronic data and news flow. Dow Jones, a financial newswire, has even developed a service called “Lexicon”.

It analysts news stories to identify information that might impact on sentiment towards particular stocks, or markets, turning it into a form capable of interpretation by the machines which increasingly run Wall Street, and the City of London for that matter.

Some estimates suggest that these machines are responsible for 70 per cent of the trading through America’s stock exchanges and it might be even higher than that and where Wall Street leads the City usually follows.

Not for nothing on Monday did the long time market commentator David Buik remark in his blog that trading volumes were “unusually high” for August.

He suspected they were "algorithm/programme trade inspired”. And he was probably correct.

With Shanghai in free fall and market sentiment negative across the board it’s not hard to see why the Dow dropped so dramatically when it opened.

The computers pushed through a vast weight of sell orders at a time when there was little or no buying going on on the other side, sending the market into free fall.

Given their increasing power over the market there is a high likelihood that this sort of thing will re-occur. And not just in August.

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