In his report, Kolanovic explains how the major market trends that occurred after the 2008 crisis exacerbate selling during moments of panic. The massive shift from active to passive managed investments — he estimates that $2 trillion has moved that way in the past decade — has removed a pool of buyers who can swoop in if valuations tumble, he wrote.
The rise of automated trading strategies is also a factor because many quant hedge funds are programmed to automatically sell into weakness, he said. Together, index and quant funds now make up as much as two-thirds of assets under management globally, and 90 percent of daily trading comes from those or similar strategies, he wrote.
“Basically, right now, you have large groups of investors who are purely mechanical,” Kolanovic said. “They sell on certain signals and not necessarily on fundamental developments, such as increases in the VIX, or a change in the bond-equity correlation, or simple price action. Meaning if the market goes down 2%, then they need to sell.”
Lastly, electronic trading desks at banks and other firms tend to withdraw when markets get rough, removing liquidity and contributing to a cascading decline in prices.