Markets are changing pretty fast- responding to regional conflicts almost instantly. This transforms their essence from focusing on value and long-term capital gain to a tool of tracking the global interdependencies of geopolitical and macroeconomic events. Lets talk about algorithmic trading and its role a little bit.
how to benefit from change
For many decades, we lived in our predictable and quiet world, giving little attention to what was happening outside our sphere of influence. This notion was ubiquitous: we, the people who lived in most developed European countries have seen virtually no wars at home since the end of World War II, resorting to wondering what was wrong if some hot spots – somewhere on the outskirts – unveiled something "out of our perceptional range".
Still, in essence, any geopolitics took place outside our "unified comfort zone". Somewhere out there in Third World countries, on the outskirts of civilization, so to speak.
A predictable world and the illusion of stability
The notion of a predictable world with meaningfully anticipated, optionally manageable and preventable events also applied to the specifics of the financial markets' world. We examined and successfully managed inflation, interest rates, national debts, unemployment rates, along with stock indices, corporate events, and a range of other economic phenomena and their indicators of varying importance. And we traded, speculated, and invested, believing that the world is a relatively stable construction driven by a certain set of unbreakable rules and interdependencies that prevent it from disarray.
The very assumption that "tomorrow everything could be blatantly different" sounded ridiculous, since "tomorrow" in essence looked the same as yesterday. Even if we weighed everything that happened outside our world of comfort.
Geopolitical chaos and new rules of the game
Yet, it becomes increasingly evident that the old balances of power no longer hold their formerly unquestionable supremacy, while old agreements and rules are no longer effective. Simultaneously, new, sometimes prohibitive for the very existence of standard trade relations, barriers to the flow of goods and capital, and sanctions, rather than the "old-fashioned" embargoes, are coming into play. Against the backdrop of all this, geopolitical events and conflicts have advanced to the forefront of every investment decision, seemingly disrupting the traditional market behavior forever.
What will happen when “Pandora's box” is eventually opens? We do not know. Perhaps everything will simply calm down and return to normal. Or maybe the world will break into several pieces and revert to a state reminiscent of what it was a hundred years ago. For us, as greedy and pragmatic individuals, the key question here is how to profit from the ongoing chaos now.
Capital flows at a time of stress
When it comes to tracking capital flows in this time of stress, they now appear surprisingly omnidirectional.
On the one hand, for many decades, the principle "at the time of fear and distress, move capital to America" has been working flawlessly. Investors have long regarded the U.S. as the ultimate safe haven, drawing capital whenever the smell of gunsmoke begins to spread.
On the other hand, it is possible to identify the opposite flows more and more clearly. Some temporary ‘havre de choix’ appear, offering conditionally stable regions with attractive regulations or taxation. These regions actively avoid the crossfire of modern conflicts or provide a convenient transit hub for those aiming to navigate this turbulent period without speculative risks.
Among them, it is worth noting the growing relevance of cryptocurrencies. For a long time, interest in cryptocurrencies was based on techno-anarchic romanticism. Something like "here we are now going to make a system of currencies and technologies independent of central governments and transnational corporations, and build a crypto paradise on earth for the smart ones like you and I".
The euphoria has subsided though. ICOs turned out to be sometimes a scam, and most importantly – with all the very interesting technical solutions in the DEX domain, the cryptoworld remained very much detached from the world of the real economy. However, a new paradigm with emerging crypto-pegged national currencies and crypto national sovereign funds is giving them more and more legitimacy again.
Does algorithmic trading really add more fuel to the fire of chaos?
Nevertheless, I would not argue that algorithmic trading necessarily accelerates the spread of existing market risks. In fact the risks of algorithmic trading itself and the risks caused by the new, geopolitically less stable world can interact, intertwine, mutually reinforce each other and even generate new opportunities. Hence, it is crucial to distinguish between the risks associated with algorithmic trading and those related to geopolitical instability.
Algorithmic trading is poorly adapted to any kind of chaos. It is built primarily on statistical confluence rules. One of the fundamental pillars of statistical methods is the invariance of the system. We believe that the parameters and current state of the system may change.
Still, if we had enough time to conduct uninterrupted observations, then describe, and build a working model, we would be foolish to expect it to remain foolproof for its lifetime. Furthermore, it is believed that, literally, yesterday should always turn into tomorrow – with just slight variations.
However, the truth is that every model is finite, and at some point, it ceases to describe the changing reality accurately. And of course, different models have different time horizons.
If you trade HFT at the rate of tens of thousands of deals per day and your model becomes "broke", i.e. stops reflecting reality, you will learn about it very quickly. Literally tomorrow during the next trading session. However, if you trade a ‘slow’ strategy, such as a commodity strategy with only a few trades per month and positions held for months, you must accurately assess your model’s lifespan and retire it in a timely manner.
Benzinga Disclaimer: This article is from an unpaid external contributor. It does not represent Benzinga’s reporting and has not been edited for content or accuracy.
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