The stock market is particularly vulnerable to wild swings right now due to a combination of thin liquidity and headline-driven algorithmic trading bots.
That’s what helped turn a false tweet about U.S. President Donald Trump’s plans for tariffs into a US$2.7 trillion market rebound on Monday, and is fueling another jump in U.S. stocks today.
As traders grapple to keep up, market makers dial back, making trading more expensive — and making equity markets extremely volatile. Those conditions remain in place, with the S&P 500 surging more than 3 per cent when the latest session began.
“Liquidity is terrible, so anyone with just a decent-sized order is going to move the market,” Brent Kochuba, founder of the options data provider Spot Gamma wrote in a research note to clients on Monday.
When traders talk about liquidity, they mean the ease at which investors can buy and sell financial instruments. That dried up at times on Monday amid a frenzied eight-percentage-point round trip in the S&P 500. In the options market, bid-ask spreads briefly jumped three-fold. Liquidity remained sparse during the European trading day on Tuesday.
The conditions amplified the 180-degree turn in sentiment on Monday, aided by momentum-driven trading algorithms primed to react to sudden changes in market direction, according to Benn Eifert, managing partner and co-chief investment officer at the hedge fund QVR Advisors.
“Big trades just push the market really fast,” he said.
In the options market, on three occasions on Monday morning, the bid/ask spread jumped more than three-fold in a matter of seconds on three occasions Monday morning. That’s higher than it was during the selloff last week.
Eifert says the way market makers and hedge funds are programmed to trade on news contributed to the market reaction to the tariff headline. Automated trading systems can pick up shifts in market sentiment in milliseconds, exacerbating price swings.
“You have a daisy chain of buying reactions in response to a headline,” Eifert said. “Algorithms are tuned to react extremely quickly to any kind of headline reversing tariffs.”
Similar liquidity issues were cropping up in the futures markets, where the market-making firms that typically offer constant trading appeared to dial back their footprint, pushing up the bid-ask spread that determines the price of trading.
The thin order book in CME E-Mini S&P 500 Futures on Monday was a sign of market strain, Eifert said. S&P E-mini top of book depth dropped to $2 million at points on Monday, the widest gap between volume and liquidity on record, Goldman Sachs Group data indicates.
An investor wanting to put through a trade of $100 million is going to “chew through many, many levels of the orders stack, and they’re going to move the market quite a lot with that trade,” Eifert said.
Futures are an important tool for market makers to hedge risk, so thin liquidity in futures trading can spiral into other areas. A similar dynamic may have contributed to the opening rally today.
Thin liquidity was apparent when markets swung dramatically on a volley of false headlines that created confusion on Monday about whether the White House would be delaying the tariffs announced last week.
The S&P 500 jumped from being down nearly 5 per cent to up as much as 3.4 per cent, after some news outlets carried headlines suggesting the Trump administration was considering a 90-day pause on the tariffs. The White House quickly denied the substance of the reports, pushing prices back down again.
The erroneous tariff pause headline, “shows how skittish the market mood is,” said Steve Sosnick, chief strategist at Interactive Brokers.
Options market makers were waiting for a “few seconds” to ensure they were sufficiently hedged against moves in the underlying stock market, before starting to quote again, according to said Gareth Ryan, managing director of IUR Capital Ltd., a London-based investment advisor.
“Intraday swings of this magnitude on both single names and index options make it very difficult to achieve both price discovery and mark-to-market,” Ryan said.
Bernard Goyder, Bloomberg News
--With assistance from Natalia Kniazhevich and Michael Msika.
©2025 Bloomberg L.P.
