ETFs, ETNs and what it all means…

When we were growing up market volatility could be easily witnessed at trading desks and on the floors of the various exchanges, as well the trading floors of large trading firms.   People were responsible for the buying and selling that took the markets to new heights and also dropped the market to new lows. In today’s technologically advanced society, computers armed with algorithmic trading models have shown us they are the new masters of the market universe.

If you are wondering how we got here, well this is not the first time that the market has been rocked by autonomous or algorithmic trading.   If you think back several years ago to the “Crash of 2:45” is the moment in 2010 when computerized trading models trading Exchange Traded Funds (“ETF’s”) took the market down significantly. The Dow Jones Industrial Average had its second largest intraday drop losing about 9% within minutes. The markets recovered quickly but this event gave rise to the new market shift of computerized trading models reacting to market data.  The crash is so named for the time of day that it occurred. What is most important to take away from it is the amount of time it took for the market to drop so significantly. A matter of minutes.

Fast forward to 2018 and the market’s new traders are not only part of the reason the market has gone to new heights but have also been a main catalyst to the market having a volatile trading range. Additionally, these models that track indexes and look for specific data that signals a market move are the largest factor in the momentum movement we have seen over the past week to ten days.

Unfortunately, most human traders had become complacent in the market continually moving up and having an even keeled trading range.   Once there was a fundamental shift in market sentiment and/or market movement the algorithmic trading models that follow indices and the products built around them, ETF’s and ETN’s were responsible for increasing momentum almost exponentially as they trade faster than humans.  They also think geometrically and can plot trading three to four trades out not just one trade at a time.

These newly minted products that Wall Street has cooked up are responsible for approximately 30 plus percent of the total market trading in the past ten days.   Think about the record volume that was generated over the past week and that is a significant amount of trading.   Take that to its inevitable degree and that makes the firms running these products some of the largest market participants ever.

Moreover, the trust that the street has put into investing into these products where the overall strategy is to follow an index or invest against it autonomously is a new paradigm shift in investing.   Following indexes is nothing new nor is betting against them. But for the past fifty years or so that is something human beings would do.   There was a level of thought process a human trader must go through as well as some emotion mixed in there as well.   What has happened now is autonomous trading that has been programmed, so well as a matter of fact that it performs outside the scope of mental and emotional decision making. What you have witnessed this past week are these models taken to their farthest point.   Protecting and defending the capital they trade on by exponentially accerelating the market direction as they vie for their position of defense or offense.

According to market pundits these publicly traded funds have had investments made in them equaling trillions of dollars. Whereby these types of funds now own close to 35% of all equities in the United States, which is a staggering number.   So one can see why when they have a change of direction or their algorithmic model reaches a trigger; their trading decisions majorly affect the overall market.

This past week the world’s largest ETFs that were traded heavily are those of one of the world’s largest asset managers, none other than BlackRock.   They have approximately over $5 trillion in total assets and have a bit over $1 trillion of that in their ETF sector. (yes that is Trillion with a T)   These dominant market forces have set the new paradigm for how equities will be traded. There was no pandemonium during the market hours on the ETF section of the BlackRock trading floor.   There were just technicians watching as computers executed trades based on their programing. This my friends is the new way of the trading world. Eventually, humans will have much less to do with trading, as computers will be able to learn from each market day and figure out nuances in each and every market segment.  Or so the theory goes…

What is most important to remember during this new frontier in trading is not to get sucked into the market shift based on computerized trading. What changed over the past week or so besides the question of three rate hikes to four rate hikes this year? Most likely nothing.   The market is weary of its meteoric rise over the past several months and market factors like inflation and interest rate hikes loom.   All in all individual investors should be careful not to risk too much in these uncertain market conditions.  The other piece of the ETF or ETN pie we have witnessed is the exorbitant use of leverage attached to ETF and ETN trading.  Some of what we witnessed this past week is the deleveraging and decoupling of linked trades in the algorithmic matrix of many of these funds.  What does all that mean?  Well it is quite technical and will be the focus of some future articles here at The Ribotsky Institute, but it is something that creates movement in indexes that cannot be specifically correlated to fundamentals.  So you are are sitting at work and/or home looking at market information and wondering why the index is moving here or there as there is no known fundamental change to shift it.   (now you know why)

One thing is for sure, is that different forces are driving the market and the rest of Wall Street is trying to catch up….

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