The Misbehavior of Algorithms

Any sober trader watching the euro/dollar pair must be blushing of late, as the bacchinal Euro Bulls Gone Wild party is in full swing. It used to be human fear and greed that placed markers on the charts for the astute observer to parse. But lately the bread crumbs lead to a secret algorithm trading cave buried in the Carpathians or Pyrenees or some such European mountain range.


It has been nearly a year since we were alerted of European quant funds using the European 2-year swap spread to pair trade the euro/dollar pair. The game is one of mean reversion assumption. When the EUR/USD spot drops a statistically significant amount below what is implied in the 2-year swap spread, well then we buy the euro. And once one algo house starts making euros, it doesn't take long for the neighborhood algos to take notice and pile in.  I'm not prepared to state how this scheme will blow up in everyone's face, but I'm fairly certain it's not "quote"   -- sustainable.

In the meantime, it might be most useful to figure out the formula of this brain-child. If you know what they are going to do en-masse, then you can either step aside or party like it's 2012.

We can still analyze fundamentals, technicals and human behavior. But we must now also study the behavior of algorithms, a rising player in markets worldwide. Don't be scared. Remember that The Matrix and Terminator both had happy endings. As I recall anyway.