Computers Blamed (Again) for the Market's Woes

As the Dow has yo-yo'd through the past week, a familiar criticism has risen from the crowd. It's the computers fault!

Take this article from ABC, "High-Frequency Trading May Magnify Market Woes," in which the author leads with the idea that "experts believe that computer-driven high frequency trading is partially responsible for accelerating stock gyrations."

It's not that algorithmic trading couldn't have negative repercussions like last year's flash crash, but we know that there are so many human factors driving the markets crazy that we need real evidence for algorithmic hijinks before we should blame the bots. People like to scapegoat computers when the market starts doing things that are beyond any human's ability to tell a plausible story about. Dow down! Dow up! Dow down! Dow up! It must be the computers' fault!

Blaming computer-assisted trading has been a go-to strategy to explain market dips since the October 1987 market crash. "This computer-assisted trading trading has been credited with helping feed the remarkable run-up in stock values that began in 1982," the AP wrote days after the crash. "But in the wake of Monday's historic 508-point plunge in the Dow Jones Industrial average, the technique was being viewed as a destructive force." The Miami Herald was less measured; its headline read, "Computers Bring Doomsday to Wall Street." Even technology evangelists like the ones featured in the video above take it for granted that computerized trading might one area where computers were dangerous.

A lively and still unsettled academic debate ensued about the role of algorithmic trading, or program trading*, as it was then known, during the crash. Did it cause or exacerbate or have no effect on the market collapse? Various investigators told different stories with different data, as summarized nicely in a 1989 paper by Dean Furbush. "There is still no consensus as to the role of program trading in the crash."

In the popular imagination, though, computers certainly played a role in the crash. In 1988, the New York Times wrote, "The story of last October's stock market crash featured one notorious villain: program trading." The Times also noted that the practice hadn't gone away. In fact, computerized trading strategies have only become more prevalent over the 24 years since that crash.

Now, computers execute something like 75 percent of the trades on the major exchange, and when the markets are running smoothly, they seem to have a salubrious effect. But as a generally positive academic paper on the computerized practices concludes, "it remains an open question whether algorithmic trading and algorithmic liquidity supply are equally beneficial in more turbulent or declining markets."

Whatever the reality of the situation, when all hell breaks loose, we don't really trust the machines. We want some wet, sentient mammal eyes staring back at us when the bad times come. We want traders who feel pain. Like these guys, courtesy of The Atlantic business team:

And yet here's what 80 percent of the trades really looked like, so it's about time we stopped relying on romantic or nostalgic notions about human traders.

*Furbush, for one, goes to great lengths to state that 'program trading' strategies antedated computerized trading, but I think for most of our purposes, the terms can be used interchangeably here.

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