Volatility: what happens when senior traders take a break
Equity market volatility has caught many people by surprise over the last two weeks. But if investors took a snapshot of end-of-summer trading over some recent years, they might have been more prepared. Turns out, markets can overreact to late-summer news when senior traders are on vacation.
Take this year. Concerns about the Chinese economy have roiled the S&P 500. In 10 of the last 13 trading days, the broad-market index has fluctuated more than 1%. For the rest of the year, that same level of volatility has registered only about a quarter of the time, according to S&P Capital IQ.
In other years, when news events have occurred in August, equities have also clocked in unusual price movements. For example, in August 2011 equity investors were concerned about a worsening eurozone debt crisis. Nearly every trading day that month posted volatility higher than 2%, and with several days at 5% or higher, versus an average of about 1.6% daily volatility over the year. Though the concerns continued into September that year, volatility was about 25% lower during that month.
Some experts say the absence of senior bankers during a holiday season can often be to blame, for two reasons. First, senior managers place trades before they go away, says Anthony Perrotta, global co-head of research and consulting at TABB Group. During vacation, they might check email, but they aren’t actively trading. As a result, liquidity dries up – meaning fewer trades are happening on a given day.
When news flow is silent, the desks are less active than normal. For example, last year volatility the last two weeks in August was only 0.5%, about half the daily volatility for the year. However “if something occurs, like if you have event risk issues in China, you will have more volatility because you have less liquidity,” Perrotta says. In other words, traders who remain at their desks might make big decisions, but fewer counterparts are around to take the other side of the trade.
Perrotta offers another reason as well. When senior traders are gone, their junior assistants take over. “Young protegees and individuals that have filled into spots may have never seen or traded in extreme volatility and bear markets,” he says. Traders might get a little trigger happy, and “this can have a negative impact on things.”
In the future, an overall shift in trading demographics might contribute to greater volatility throughout the year. “The banking world is changing significantly,” with the Volcker Rule that requires banks to hold more cash against their daily trades. “Just in general, the fun of being a front-office person on the banking side has dissipated,” he says.
Young traders are seeking other opportunities, and many are flocking to hedge funds. While they are highly educated, their lack of experience can cause trading jitters. “They are going to have a drain on the type of decisions and judgments that are made in periods of extreme volatility,” he says.
