Market Shocks May Be Here To Stay

Market Shocks May Be Here To Stay

almost 4 years ago2 mins

Mentioned in story

Fresh coronavirus panic pushed global stock markets down once again on Friday. But some investors believe that structural changes to investing exaggerate the scale of such moves – and they’re warning that these shocks may only grow more common 😟

What does this mean?

After months of placidity, recent market madness saw the Vix index tracking US stocks' volatility experience its biggest one-week jump since the 2008 financial crisis. Similarly violent shocks have, however, become more frequent in recent years.

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Ironically, this may be due to an increased focus on volatility itself. The heightened popularity of derivative investments like options, which can help “hedge” market bets, normally reduces turbulence. But when volatility does increase, investors scrambling to cover their backs can create a vicious circle – one investment bank JPMorgan estimates caused an additional $50 billion of selling recently.

That’s especially true when investors rely on “volatility” as shorthand for “risk”. Some funds automatically limit their exposure to a market based on its volatility level – an approach which may have contributed an extra $150 billion to late February’s stock market selloff 🤯

Why should I care?

When everything’s hunky-dory, such systemic changes have little visible impact. But whereas human investment bankers were still doing much of the buying and (mainly) selling at the time of the last financial crisis, the subsequent rise of the machines makes modern downturns potentially even more dangerous.

The dominance of data-driven “high frequency trading” today can see buy and sell orders for stocks algorithmically dry up when volatility spikes. And that lack of market “liquidity” means any trading that does occur has an exaggerated impact on price moves ⚖️

The recent correction is, of course, rooted in coronavirus-driven concerns about economic growth. As well as making the calm times calmer, however, underlying structural changes may leave any market shocks that do occur looking more intense than they would have previously.

Source: Twitter/Bloomberg
Source: Twitter/Bloomberg

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