Date
28 May 2018
The suddenness, speed and scale of the recent Wall Street selloff prompted some observers to point the finger at machines and algorithmic trading. Photo: Reuters
The suddenness, speed and scale of the recent Wall Street selloff prompted some observers to point the finger at machines and algorithmic trading. Photo: Reuters

Why we can blame AI systems for the global equity slide

With technologies detecting the surroundings, self-driving cars built with artificial intelligence (AI) can navigate without human input. They can even determine the best route.

However, it’s possible that all the vehicles would choose the same path. That in turn may lead to bad traffic jam.

In fact, this potential issue has been admitted by several self-driving experts at the CES 2018 event held in Las Vegas last month.

The same thing can happen to AI systems behind stock trading.

Before a strong rebound on Tuesday, the Dow Jones Industrial Average slumped over 1,800 points in two trading sessions, causing a market sell-off worldwide.

Since algorithmic trading now accounts for 75 percent of US stock market trading, the dramatic swings of the market can probably be attributed to the passive group-thinking patterns of these programs, which are typically based on historical data plus certain trading theories.

Certain condition could trigger a sell action from numerous robot traders, and then selling pressure begets more selling.

There is no other obvious explanation for the dramatic shift in market sentiment.

We’ve seen a similar market crash on October 19, 1987, when the market plunged 20 percent on a single day without any obvious trigger.

Back then, someone already blamed machine trading.

Computer programs are supposed to be much smarter now, but at the same time, algorithm accounts for a much higher share of the US market trading, thus amplifying their impact.

Benjamin Graham, the father of value investing, said that every day Mr. Market tells you what he thinks your interest is worth and furthermore offers either to buy you out or to sell you an additional interest on that basis.

Ninety-five percent, Mr. Market makes you a fair price. But 5 percent of the time, he lets his enthusiasm or his fears run away with him, and the value he proposes seems to you a little short of silly. That’s the best time for the investor to buy or sell.

Mr. Market may panic more frequently as machine trading has dominated the market. Therefore, investors should be more cautious in risk management and position control. Also, they better not use leverage, while keeping enough ammunition all the time.

This article appeared in the Hong Kong Economic Journal on Feb 7

Translation by Julie Zhu

[Chinese version 中文版]

– Contact us at [email protected]

RC

Hong Kong Economic Journal columnist

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