The Rise of Algorithms: How Machines Move Markets

The Rise of Algorithms: How Machines Move Markets

This week’s reader question: What is algorithmic trading and is it causing the volatility we’re seeing today in the stock market?

Quantitative Investments Manager Josh Jurbala had this to say:

Great question on a very relevant topic.

First, let me explain what we mean by algorithmic trading: An algorithm is a rules-based process for performing a task, typically involving mathematics and computer-based calculations. In financial markets, “algos” execute complex calculations at a faster speed and with less human error and behavioral bias than people can achieve on their own.

In the case of trading, algorithms can be used to automate decisions and change portfolio allocations according to sets of rules. The subset of algorithmic trading most prevalent in today’s markets is called high-frequency trading (HFT). HFT firms use algorithms (along with powerful computers and extremely fast internet connections) to identify trade opportunities and execute large orders at lightning-fast speeds.

Photo of quantitative investmnets manager Josh Jurbala and a quote stating "Long-term investors, like our clients, should not be concerned by the rise of machines in day-to-day trading. We’re very careful to make sure your portfolio is properly positioned with your personal goals and risk tolerance in mind.”

Algorithmic and high-frequency trading “grease the wheels” and improve market liquidity and price discovery. This makes it easier for buyers and sellers to transact at consistent prices, which can lower overall trading costs for retail traders and low-frequency trading investors like us. The increased volume from electronic trading can also dampen volatility and benefit stock performance, especially during positive-trending bull markets.

The main risk of HFT—which by some estimates accounts for 50% of stock trading volume—is that automated trading can also exacerbate volatility, particularly during a crisis or sudden market sell-off. This phenomenon was brought to light during the famous “flash crash” on May 6, 2010, when stocks suddenly plummeted in a matter of minutes, before recovering nearly as fast that same day.

At Adviser Investments, our tactical strategies (subadvised by our Adviser Capital division) use algorithms to measure price momentum and determine trades, regularly adjusting portfolio allocations to manage risk and follow market trends. But unlike the strategies discussed above, our client portfolios trade less frequently (over days and weeks) and in lower volume with minimal market impact. In other words, we use algorithms as a short-term means to achieve long-term investment objectives.

Long-term investors, like our clients, should not be concerned by the rise of machines in day-to-day trading. We’re very careful to make sure your portfolio is properly positioned with your personal goals and risk tolerance in mind, so there should be little need to trade intraday, and minimal chance for your portfolio to get derailed by fleeting volatility.

 

Ask Us a Question!

We’re always interested in the topics or concerns you might like us to comment on. Ask us a question about investing, the markets or financial planning and one of Adviser Investments’ experts will answer it in a future edition of The Week in Review. CLICK HERE NOW TO POSE YOUR QUERY.

About Adviser Investments

Adviser is a full-service wealth management firm, offering investment managementfinancial and tax planningmanaged individual bond portfolios, and 401(k) advisory services. We’ve been helping individuals, trusts, institutions and foundations since 1994. Adviser Investments and its subsidiaries have over 5,000 clients across the country and over $8 billion in assets under management. Our portfolios encompass actively managed funds, ETFs, socially responsible investments and tactical asset allocation strategies, and we’re experts on Fidelity and Vanguard mutual funds. We take pride in being The Adviser You Can Talk To. To see a full list of our awards and recognitions, click here, and for more information, please visit www.adviserinvestments.com or call 800-492-6868.


For informational purposes only. The investment ideas and opinions contained herein should not be viewed as recommendations or personal investment advice or considered an offer to buy or sell specific securities.  All investments carry risk of loss and there is no guarantee that investment objectives will be achieved. Past performance is not an indication of future returns.  Always consult a financial professional before taking specific action. Tax, legal and insurance information contained herein is general in nature, and should not be construed as legal or tax advice, or as advice on whether to buy or surrender any insurance products. Personalized tax advice and tax return preparation is available through a separate, written engagement agreement with Adviser Investments Tax Solutions. We do not provide legal advice, nor sell insurance products. Always consult a licensed attorney, tax professional, or licensed insurance professional regarding your specific legal or tax situation, or insurance needs.

© 2022 Adviser Investments, LLC. All Rights Reserved.