The Dow Jones Industrial – A current stability or a future instability?
The Dow Jones Industrial average is closing in on 13,000, but is this any indication of stability in the markets? Most analysts say stability is simply not in the cards until emerging markets can be reigned in.
It was May 6,, when the Dow industrial dropped more than 1,000 points in less than 20 minutes. This ‘flash crash’ was initially thought to be a terrorist attack or the work of an independent hacker looking to make a quick buck. Once the dust settled and investigators with the Securities and Exchange Commission had an opportunity to delve into exactly what happened they discovered the cascade was caused by a trader who mistakenly tried to sell the wrong amount of a security connected to the S&P 500 index. He typed in an extra “0” and that was enough set off a chain reaction that resulted in the most severe drop in the shortest period of time ever seen in the markets.
Coming as it did in the midst of a recovery from the Great Recession, investors should have been spooked, but they bounced back hard and shook off the debacle like water off a duck’s back. For investigators, however, the situation was a serious wake-up call to what is wrong with the stock market.
Almost immediately the SEC instituted new rules meant to prevent just this type of problem from happening again. First, they expanded the use of “circuit breakers” to include exchange traded funds and stocks. These ‘circuit breakers’ will stop trading if a stock or an index falls too far down in too short of a period. This definitely had an impact on the U.S. stock market. Volatility was severely handicapped, which was good news for long term traders, but bad news for high frequency traders who make their living buying stocks at low-lows and running them up. Without volatility they don’t have as many opportunities to buy low and sell high. Rather than settling for a market with more predictability and less swings, some investors fled to foreign markets where regulation has not yet grabbed hold.
Unfortunately, even in foreign markets the domino effect can still impact what happens here at home.
High frequency trading is a strong source of revenue for stock markets in some still developing economies, where less stringent trading rules are in place. These markets are also a choice breeding ground for another ‘flash crash’ similar to what happened to the Dow Jones in May of 2010. In places like Russia, South Africa and South America, stock markets remain places where volatility sometime rules the day. It is in this volatility where high frequency traders see their profit margins. They have flocked to these places hoping to take advantage to the type of Wild West environment which still rules.
The World Federation of Exchanges says that investment in global stock exchanges (those outside the United States) is up a full 10 percent this year over last year. Unfortunately, nearly all this growth came from the influx of high-frequency traders and the investment they bring with them.
As high frequency traders look to take full advantage of fewer restrictions in foreign markets we should keep in mind the inter connectedness of the global economy. Just because it happens a half a world away does not mean the United States is immune from it effects. In fact, just the opposite. With so much outside capital pouring into foreign markets it seems even more likely that what happens half a world away will likely be felt right here at home.