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Study offers hope we could predict the next market crash

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Study offers hope we could predict the next market crash

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Could rapid stock-price changes caused by computerised trading be responsible for recent stock market crashes?

A new study has analysed price logs from 60 markets worldwide, and found evidence of a pattern.

Before the stock market crash in 2008, prices of some stocks shot up and down at incredible speed, often returning to their previous levels within half a second.

The changes- which the researchers describe as 'fractures' - could be key to understanding what causes stock market crashes

They could also offer an 'early warning system' for when the markets are becoming unstable.

The 'fractures' occur so quickly they would be invisible to any human trader, existing in a world of computerised trading algorithms which make trades in milliseconds.

The same ultra-fast changes preceded another, smaller crash in 2010 - the so-called Flash Crash.

The researchers, led by Neil Johnson at the University of Miami in Coral Gables analysed 18,520 'fractures' between 2006 and 2010.

Johnson told New Scientist that ultra-fast trading systems themselves could be to blame for the crashes.

He found that 'fractures' of less than one second followed a different statistical pattern to ones of more than a second - the difference between price changes a human trader could follow and ones a human couldn't.

On shorter timescales, Johnson says, computers effectively control the stock market.

'Nobody really knows what's going on down there,' says Johnson. 'It's like the Wild West.'

The study analysed price logs from 60 markets provided by Eric Hunsader of Nanex, a Chicago-based company that sells streaming market data.
Johnson thinks that the changes could build up in the system in much the same way as an accumulation of cracks in an aircraft's wing.

'You're seeing something starting to break open,' says Johnson.
Johnson hopes to understand how 'fractures' work, and possibly use them to build an 'early warning system' for financial crashes.

'Johnson makes a compelling case,' says Dave Cliff, an expert in complex systems at the University of Bristol, UK.

'Developing his analysis techniques into methods or tools for reliably predicting crashes is a very appealing prospect.This work could turn out to be a major first step in that direction.'

Read more: Could tiny 'fracture' surges in the stock market be the spark that lights the fuse for financial meltdown? | Mail Online

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February 11, 2012

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