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ETFs And Flash Crashes: Season Of The Glitch

ETFs And Flash Crashes: Season Of The Glitch by Ben Hunt, Salient Partners

When I look over my shoulder
What do you think I see?
Some other cat lookin' over
His shoulder at me.
Donovan, "Season of the Witch" (1966)
Josh Leonard: I see why you like this video camera so much.
Heather Donahue: You do?
Josh Leonard: It's not quite reality. It's like a totally filtered reality. It's like you can pretend everything's not quite the way it is.

“The Blair Witch Project” (1999)

Over the past two months, more than 90 Wall Street Journal articles have used the word “glitch”. A few choice selections below:

Bank of New York Mellon Corp.’s chief executive warned clients that his firm wouldn’t be able to solve all pricing problems caused by a computer glitch before markets open Monday.

“BNY Mellon Races to Fix Pricing Glitches Before Markets Open Monday”, August 30, 2015

A computer glitch is preventing hundreds of mutual and exchange-traded funds from providing investors with the values of their holdings, complicating trading in some of the most widely held investments.

“A New Computer Glitch is Rocking the Mutual Fund Industry”, August 26, 2015

Bank says data loss was due to software glitch.

“Deutsche Bank AG (NYSE:DB) (ETR:DBK) (FRA:DB) Didn’t Archive Chats Used by Some Employees Tied to Libor Probe”, July 30, 2015

NYSE explanation confirms software glitch as cause, following initial fears of a cyberattack.

“NYSE Says Wednesday Outage Caused by Software Update”, July 10, 2015

Some TD Ameritrade Holding Corp. customers experienced delays in placing orders Friday morning due to a software glitch, the brokerage said..

“TD Ameritrade Experienced Order Routing, Messaging Problems”, July 10, 2015

Thousands of investors with stop-loss orders on their ETFs saw those positions crushed in the first 30 minutes of trading last Monday, August 24th. Seeing a price blow right through your stop is perhaps the worst experience in all of investing because it seems like such a betrayal. “Hey, isn’t this what a smart investor is supposed to do? What do you mean there was no liquidity at my stop? What do you mean I got filled $5 below my stop? Wait… now the price is back above my stop! Is this for real?” Welcome to the Big Leagues of Investing Pain.

What happened last Monday morning, when Apple Inc. (NASDAQ:AAPL) was down 11% and the VIX couldn’t be priced and the CNBC anchors looked like they were going to vomit, was not a glitch. Yes, a flawed SunGard pricing platform was part of the proximate cause, but the structural problem here – and the reason this sort of dislocation WILL happen again, soon and more severely – is that a vast crowd of market participants – let’s call them Investors – are making a classic mistake. It’s what a statistics professor would call a “category error”, and it’s a heartbreaker.

Moreover, there’s a slightly less vast crowd of market participants – let’s call them Market Makers and The Sell Side – who are only too happy to perpetuate and encourage this category error. Not for nothing, but Virtu and Volant and other HFT “liquidity providers” had their most profitable day last Monday since … well, since the Flash Crash of 2010. So if you’re a Market Maker or you’re on The Sell Side or you’re one of their media apologists, you call last week’s price dislocations a “glitch” and misdirect everyone’s attention to total red herrings like supposed forced liquidations of risk parity strategies. Wash, rinse, repeat.

The category error made by most Investors today, from your retired father-in-law to the largest sovereign wealth fund, is to confuse an allocation for an investment. If you treat an allocation like an investment… if you think about buying and selling an ETF in...


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