Oil price fluctuations: is algorithmic trading to blame?

During the first half of 2017, oil prices were subject to serious fluctuations, showing a downward trend inherent in the “bear market”, even despite a reduction in the supply of raw materials.

Typically, investors and energy analysts blame algorithmic trading for price unpredictability, but in the current situation even they were surprised: based on fundamental information, price rises seemed obvious to them, writes The Australian.
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According to oil investors, the extraction of raw materials and the demand for it are no longer driving forces in market pricing. They argue that software trading distorts the situation and provokes price fluctuations. Take, for example, the situation of May 25: even after the OPEC member countries decided to continue reducing raw materials production , oil prices fell by almost 5%.

In view of what is happening, some analysts attributed the fall in prices to, perhaps, an even greater reduction in supply from OPEC, others explained the situation by the actions of algorithmic traders.

Saudi Arabian Prime Minister Khalid al-Falih was one of those who linked the events of May 25 with the actions of technical traders. “Then many people wanted to sell the shares,” he said after the OPEC meeting on May 25. "But the fall in prices has intensified after the price has overcome certain technical barriers."

According to the Commodity Futures Trading Commission, automated trade in “energy” contracts (shares) from the end of 2014 to the end of 2016 was 58 percent, whereas in the previous biennium, its level was 47 percent.

EIA's weekly reports on changes in oil and petroleum products in the United States still play an important role in the commodity market, but price fluctuations did not increase because of them, but at the expense of algorithmic trading.

On March 8 and 9, US stocks showed a record level. However, after the algorithms entered the game, the price of oil fell below $ 50 a barrel - for the first time in a year.



“More and more traders are being led by flashy headlines, rather than counting real volumes of oil,” said Michael Tran, director of energy strategies at RBC Capital Markets. “Many of them are algorithmic traders or quanta.”

Each of the funds has its own strategies, which makes it extremely difficult to determine the effect of algorithms and automation on them. As Michael Lipstick, executive director of Crabel Capital Management, says, “people tend to blame things on things that they don’t understand.”

Yes, indeed, the basis of algorithms is often a complex methodology. The time of buying and selling stocks is determined using the following indicators - moving averages (MA) and volatility.

Traders, on the other hand, can combine knowledge of mathematical models with their own observations in order to make financial bets on price movements from one day to several months.

Despite the fact that both people and algorithms use automated mechanisms on the exchange, an increase in the number of such operations indicates a growing influence and increase in the speed of computers in the oil trade.

Automated trade also captures other areas: for example, according to the CFTC report , its level in agriculture has increased to 49% in the past two years (until the end of 2016) against 38% in the past period. The same can be said about the metal market, where the percentage of algorithmic trading was 54% compared with 47% from 2012 to 2014.

However, oil prices are still more subject to fluctuations than prices in other industries, including because of the recent actions of OPEC. Momentum traders using algorithms feel market trends, says Peter Hahn of the Bridgeton Research Group. He also said that the oil market is now in a state of transition. “In such a market, trading systems based on pulsed algorithms will“ stand out ”from long and short positions.”

Some algorithmic strategies are well funded: for example, last year $ 25.5 billion was invested in stock options commodity advisers (CTA), many of which, according to Preqin, use algorithms to track trends in the futures market. In the first quarter of this year, CTA attracted another $ 7.2 billion, after which the total amount of their funds amounted to $ 256 billion.

According to Goldman Sachs, exchange consultants can create new trading opportunities in the market. “Fundamental investors should not be afraid of CTA-funds. Their activities should be considered as a source of new income opportunities, since they lead the market away from strictly following fundamental indicators, ”writes the investment bank in its report on raw materials from June 29.

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