Technology Exaggerates China-Led Crash

It has been a bad few days in the global stock markets. China’s general ineptitude at running capital markets has resulted in a nasty property bubble and a possible market slowdown. As the second largest economy in the world, when China sneezes the rest of the planet needs to reach for the aspirin and decongestants. Trillions were wiped off the value of shares around the world, and for one session, the Dow opened down 1,000 points. The market has made back much of that loss. While some prophesy a collapse worse than 2007-8, what is happening here is weeks of trading happening in seconds because of technological developments.

Reuters reported this morning, “The two main Chinese indices surged 5.3 percent and 5.9 percent CSI300 on Thursday, snapping a five-day losing streak that had wiped off around 20 percent from market value and sent tremors around global financial markets.” These are still significant declines, and the decline is consistent with a correction to an over-valued market. However, the bounce back suggests that the market over-shot by a huge amount.

Markets inevitably move too far up and too far down when prices change significantly. Selling at the to and buying at the bottom are ideal, but seeking to do so as an investment strategy is a sure way to bankruptcy. Every trader knows that “the trend is your friend.” Buy when prices are rising and sell when they are falling. The statement “at price X is where the trend reverses” can only be made several days later with the charts proving it.

Crashes and surges result, and those with trading experience know that markets are not driven by supply and demand. Greed and fear make prices move. Irrational behavior is a hallmark of markets. Human behavior forces them to behave that way.

Thanks to computers and instantaneous communications, the panic that sets in when a market crashes is amplified by taking time away from humans who trade. One doesn’t have a couple of minutes to assess the situation. Prices are in free-fall, and the last one holding the ticking time bomb is the one who stopped to think things through.

Dan Denning at Moneyweek summed it up on Tuesday, “In the era of high-frequency trading, the market was flooded with tens of thousands of quick orders to buy and sell stocks. These weren’t decisions being made by someone on the verge of retirement. Or a fund manager looking for deep value. They were drone orders.

“It’s a drone market now. And that’s what you should take away from yesterday’s trading action. The only way to make safe a market over-run by terminator traders is to shut it down. The next few days will see a nice little rally and that sense of fear that comes from the back of your brain will abate.”

Meanwhile, the US Commerce Department revised second quarter GDP from 2.3% growth to 3.7%, a pretty big difference. That may even encourage the Fed to increase interest rates at the September meeting (this journal would argue against that because the dollar is already too strong). In other words, China may not be the main issue for the markets this time next week. The algorithms will get this new information, and the basis of their trading decisions will change. It’s still an irrational market, just at the speed of light.