Another instalment in a series of articles detailing how to design a secure, income-producing portfolio

When there is a market disruption, whether it’s a major crisis or a garden-variety fluctuation, there is more instability in stock markets today than in years past. There are several reasons for this. One is that market participants with similar portfolios are likely to respond to the same event in the same way and today’s market is full of copycat portfolios. For now, suffice to say that when everyone holds more or less the same mix of stocks, and responds to a market correction in more or less the same way, it exacerbates price swings.

Another cause of worsening volatility in our modern world is that fact that, increasingly, many market participants are not human at all. That is to say, many of the entities issuing buy/sell orders are not people, but computer algorithms. These algorithms are essentially pattern-recognition machines. In the simplest terms, they are developing and following instructions like when event X occurs, take action Y. These machines may act in tandem with human traders, but they also may act in ways that are far more damaging. If powerful computers discern that selling the market and helping to precipitate a downdraft will create opportunity – because they will be able to sell high and then buy low – there is nothing to stop them from doing just that. Thus computer trading can make volatility, and downswings, far worse than they would be otherwise. To a large degree, recent stock market volatility, which has reached once in a lifetime scale, is the natural outcome of indiscriminate algorithmic trading.