Sunday, September 2, 2007

Volume drop due to vacations or wounded quant funds?

Ticker Sense posts a chart showing the sharp decline in volume on the NYSE recently. They wonder if this is due to extensive August vacations does it mean we could see some bargain hunters back in the market after Labor Day.
Vacations are surely part of the reason for lower volumes but, I think the carnage in quantitative hedge fund results is also a big factor. I know in the fixed income sectors of the market liquidity has diminished significantly. Arbitrage strategies between futures contracts and cash securities are usually traded heavily by automated electronic systems based on statistical correlations. We have seen bid ask sizes drop by 80% in some markets as many of the arbitrage funds have pulled out of the market. Some will be back as the markets normalize again but some have blown up and will not return.
The equity markets too, have many of these types of funds operating in normal times. I believe more than 30% of NYSE volume is usually program trading which is nothing more than statistical arb driven by computer algorithms. I have no numbers on how many of these players have been hurt by recent market action but I am sure the drop in volume is partially caused by a shrunken level of mean reversion strategies.

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