Goldman Sachs is cautioning its clients that computerized trading may exacerbate the volatility of the next big market sell-off.
"One theory that has been proposed for why market fragility could be higher today is that because HFTs [high-frequency trading] supply liquidity without taking into account fundamental information, they are forced to withdraw liquidity during periods of market stress to avoid being adversely selected," Charles Himmelberg, co-head of global markets research at Goldman, said in a report Tuesday. "In our view, this at least raises the risk that as machines have replaced people, and speed has replaced capital, the inability of the market's liquidity providers to process complex information may lead to surprisingly large drops in liquidity when the next crisis hits."
Himmelberg noted the higher level of computerized trading has not been truly "stress tested" during the bull market since the financial crisis. He said the increasing incidents of volatility in various markets such as the VIX spike on Feb. 5, the 10-year Treasury bond on Oct. 15, 2014, and the British pound on Oct. 6, 2016, may be precursors of a bigger one to come.