This was a question asked of Jim Simons a few weeks after the “Flash Crash” of 2010. In just a few minutes, investors were given a taste of what could go wrong in today’s world where high frequency trading is responsible for ~50% of all daily trades.
Here is some of what Simons had to say on the matter:
“For eight minutes or so some market took a dive; it came right back. I mean it came right back. It’s an important point. In 1987 when the stock market crashed it went down 25% in half a day and it didn’t recover for six months cause there was nobody there on the other side. This thing recovered, this flash crash recovered because someone made a mistake I presume, some kind of order went in that was much too big. There was nervousness in the market, it was already down 3% and it took a dive. And everyone stood back and said ‘oh my god what’s going on?’ Well, but then the algorithms kicked in and ya know, all this trading just came back and this thing disappeared in ten minutes.”
We recently experienced another dislocation in the market where stocks and ETFs were showing prices that were, and I’m guessing here, a ridiculous amount of standard deviations away from what would be considered normal. What’s important to focus on is that the last two times this happened, the situations were rectified rather quickly.
When entire sectors ETFs fall greater than 20%, the skeptic would say that’s reason enough to forever keep their money out of the stock market. The realist would understand that in an imperfect system, imperfections will appear from time to time. From where I sit, the market did a remarkable job handling the situation so quickly.
Perhaps two blog posts using the same video is a faux paux but I thought it’s worth listening to somebody who has been so successful using computerized trading systems. Watch Simons speak to this question at the 48:20 mark.