Quick View: High-speed predators pounce on volatility

As reported by FT’s Jeremy Grant, what is causing this astonishing volatility in equities? Three American academics have an answer: it is all because, at a certain point, the market loses sight of fundamentals the more trading there is – and volatility shoots up.

In a study out this week called “The Dark Side of Trading”, Ilia Dichev and Dexin Zhou of Emory university and Kelly Huang of Georgia State university, say that “high volumes of trading can be destabilising, injecting a sizeable layer of trading-induced volatility over and above the unavoidable fundamentals-based volatility”.

That may not be so surprising, given the sickening gyrations we’ve seen, but what is interesting is the study’s related finding: that, while “low to medium” levels of trading tend to benefit most investors, there may be an inflection point beyond which super-charged levels of trading accentuate volatility – benefiting “only a small circle of traders”.

That suggests there are big winners, and big losers, in markets right now. There’s no doubt that we reached those super-charged levels this week. The volume of message traffic has been huge. Messages are the electronic carrier pigeons that carry buy and sell instructions along fibre-optic pipes to and from exchanges and traders. And those pipes are bursting with messages – propelled by the huge amounts of automated, electronic trading that dominates share trading these days. That includes high-frequency traders, using computer algorithms to seek out the best prices.

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