There is an interesting piece from Mark Cuban about the illusion of liquidity in today's markets provided by HFT algorithms and how easily - to pursue the metaphor - that liquidity can evaporate so abruptly as it did in US trading on May 6th. The S&P 500 futures dropped like a stone losing more than 100 points at one point, and the DJIA managed a 1000 point plunge - all in the space of a few minutes. Hardly the kind of behavior which is designed to engender confidence in the investment community. Here are some brief thoughts on the matter which I posted in conjunction with the piece:
Ironically, in my estimation, one of the reasons why regulators have indulged HFT shenanigans is that they believed that they would bring greater liquidity into the markets - which saw an astonishing lack of liquidity in October/November 2008.
As last Thursday showed machines don't panic - they leave that to us humans - but they just decide not to run their algorithms when certain parameters/thresholds are crossed. That may be an entirely logical response (the thresholds, of course, would have ultimately been set by the algorithm's programmers), but, paradoxically, markets require fractiousness and emotions to function, and it was only when the machines were turned off and bottom fishing humans got involved that the free-fall ended.
Longer term systemic liquidity requires confidence that the playing field can produce winners and losers and that skill will be rewarded. If traders/investors sense that markets are not only casinos, but ones where an Ocean 13 type software crash can wipe out everyone, they will not want to play in them.
