Thursday, May 12, 2011

Computers and Oil's Drop

H/T Econbroswer

From Reuters:

Machine-led trading is one plausible thesis for another apparent market anomaly that occurred on Thursday. Exchange data shows that the total number of open positions in the oil market -- a number that would typically fall in a selloff -- instead rose. Normally, panicky funds selling oil en masse would cause total "open interest" numbers to shrink, as exiting investors closed out contracts. But some machines, following the market trend, may have gone further, by dumping long positions and quickly amassing sizable short positions instead.

"Computers don't care. Momentum just increases until nobody wants to stand in front of it," said Peter Donovan, a floor trader for Vantage on the New York Mercantile Exchange.

Some big Wall Street traders watched their own systems sell into the down trend but couldn't know for sure who had initiated the selling spree. They only knew that similar machines at other firms, from New York, to London, Geneva and Sao Paulo, would be automatically selling in much the same manner.

During Thursday's crash, such selling locked in profits that high-flying commodities traders have been accumulating for months. Some of Thursday's rout appears to have been more a product of the wisdom of crowd computing than of widespread human panic.

"We believe the magnitude of the correction appears in large part to have been exacerbated by algorithmic traders unwinding positions," Credit Suisse analysts wrote in a report.

High frequency trading and algorithmic trading accounts for about half of all the volume in oil markets.