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Tags: quantitative trading | market | crash | gamma

JPMorgan's Kolanovic: Quantitative Traders May Trigger Market Crash

Thursday, 27 August 2015 04:51 PM EDT

Volatility in the U.S. equity market is being whipped up by traders who don’t care what stocks are worth, according to an analyst at JPMorgan Chase & Co.

Selling by “price insensitive” investors employing strategies that take their cue from recent trends in stocks is worsening this week’s swings, according to Marko Kolanovic, a derivatives strategist at the New York-based bank. In particular, he cited forced selling by traders who hold positions known on Wall Street as “short gamma,” a bet that prices won’t move much.

The research comes about a week after the Standard & Poor’s 500 Index was knocked out of a trading range that had supported it for about seven months. Sudden moves like that one spur computerized traders to buy and sell, exacerbating moves past what is justified by the economy and earnings, Kolanovic wrote.

“Everybody knows about it,” said Julian Emanuel, executive director of U.S. equity and derivatives strategy at UBS Securities LLC in New York. “If you look back over the last five, six years, any time we have seen a period of excessive volatility like we’ve seen in the past two weeks, strategies such as those which typically are short gamma and basically need to rebalance at the end of the day.”

Kolanovic cited three types of quantitative strategies specifically: trend followers, risk parity traders and funds that adjust holdings when volatility in the market rises or falls. Such investors have hundreds of billions of dollars in assets and the power to move markets, he wrote.

Together, institutions employing the tactics could force up to $300 billion of selling in the U.S. market over the next several weeks, according to the note.

“The obvious risk is if these technical flows outsize fundamental buyers,” Kolanovic wrote. “In the current environment of low liquidity, they may cause a market crash such as the one we saw at the U.S. market open on Monday.”

The Dow Jones Industrial Average plunged more than 1,000 points in the first minutes of trading following last weekend, sending gauges of price swings in the U.S. market to jump the most on record.

Quantitative traders have been blamed for market disruptions in the past. Losses approaching 3 percent in the S&P 500 in two days in early August 2007 were ascribed in a study by the Federal Reserve Bank of New York to program traders using strategies tied to various momentum indicators.

The 19 percent retreat in the S&P 500 during August 1998 occurred as hedge fund Long-Term Capital Management, at the time one of the biggest quant funds, was imploding.

© Copyright 2023 Bloomberg News. All rights reserved.

Volatility in the U.S. equity market is being whipped up by traders who don't care what stocks are worth, according to an analyst at JPMorgan Chase.
quantitative trading, market, crash, gamma
Thursday, 27 August 2015 04:51 PM
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