This doesn't seem to be just noise. Enough people are joining the cry that something is really changing for good. Automated trading has happened for ages, but it seems it is taking over to the point of moving sectors by momentum.
There are more fail safe regulations being imposed like the Flash Crash Plan which stops trading a stock if the price drops more than 10% in 5 minute. (How do we know if these rules are applied all the time? and whether we can expect them to occur? ) It will be interesting to see if more regulation keeps coming up out of this and who might benefit.
Is there an issue? Ideally fundamentals will still hold. If stock prices or sectors are going up inflated by automated trading, they will come down on the next sector crisis; they will start seeming overpriced at the earnings call. We just need to stay solvable until finding the one paying trade. Stay in game. Cash is a good investment until it all makes sense. At least we know, it is not new. Read somewhere in 87(?), there was same high correlation between stocks and indexes. Nice research paper on guessing what eliminated the correlation. sporadic appearances over time? why only 87, only in severe crisis?
It would take so much effort to have an idea of the specific effects of automated trading that I wonder if it is not better just to follow the herd. Follow our own cattle run: If there is an 80% correlation, and the index is going up, buy more stocks of the index, or hedge the one with less chance to go down with the one with less chance to go up. (Nice easy experiment to do.) Now we get stuck in the "fitness function" of what makes so much chance. Or easy deterministic calculation, take a sample of 100, find the highest "chance" (verryyyyyy probable that it falls above the average). The same the other way, and put them against each other. But then again, Risk Management keeping track of the correlation with the index, and another stop trade in case it moves (every 3 secs?) :) Then we are just left on predicting where the index goes. Easy problem. Maybe I can win the Lexus. is it a Lexus on the "call the close"?
It will be easier to find out which sectors are more pushed by automated trading. Any new data? Health Care, Nano-Technology?
But like any other process, it is the outliers the ones you need to try to control -if there is research to proof that it is diversifiable. If not controllable, mapped and avoided. There are more rules against dropping prices than trading long, etc.
This automated trading is also not a static event, if it comes to the point of continuing the correlation of stocks and indexes, there will be new automated rules to work against this herd behavior. Indexes for example, when feeling lack of liquidity a few weeks ago, saw prices dried up and collapsed. Interesting behavior like investors don't see the same intrinsic value in index prices as in actual stocks when crisis comes uninvited.
If automated trading ends up outrunning the pockets of us mortals, in a global scale, the effect might diminish with the merging of capital markets and increase trading offerings. More complexity, less predictability, if inflated, more inefficiency, and more money to be made.
