Are Investors Normalizing Deviant Events?


Another day, another glitch.  Yesterday, the CBOE halted trading most of the day due to a software glitch.  This comes two days after the fake AP tweet that rocked the markets.  While there was a huge amount of media attention on both situations, the takeaway seems to be that investors don’t seem to really care.  CNN ran an article titled “Twitter flash crash ‘is just noise'”  where one investor was quoted as saying, “I recognize flash crashes as one of the risks of trading.”

The Chief Operating officer of the Direct Edge Stock Exchange seems to think that the fake tweet issue really was not a big deal.  He was quoted as saying:  “The fact of the matter is, it was only a 1 percent movement. It really was more of a press event.’’

Are we becoming desensitized to technology glitches and stock flash crashes?  Are we now overlooking these occurrences and now just assuming they are part of our everyday market?

Professor Dave Cliff from the University of Bristol thinks we are normalizing these events.  He refers to this as “normalization of deviance” .  Here is how Professor Cliff describes this phenomena:

Normalization of deviance occurs when the safe operating envelope of a complex system is not completely known in advance, and where events that were a priori thought to be outside the envelope, but which do not then result in failures, are taken after the fact as evidence that the safe envelope should be extended to include those events.  In this way, deviant events become normalized: the absence of a catastrophe thus far is taken as evidence that future catastrophes are less likely than had been previously thought.  The flaw in this line of reasoning is starkly revealed when a catastrophe then ensues.”

Professor Cliff bases his work off of the work of sociologist Diane Vaughan.  She studied the space shuttle Columbia disaster in 2003 and concluded it could have been prevented if it were not for the normalization of deviance at NASA.  In this May 2008 interview , Vaughan describes what happened to the Space Shuttle Columbia:

For Columbia they flew with foam debris that hit the heat shield of the orbiter wing [during lift off] and removed some tiles from it and the more they observed such debris hits the more they considered that they had no safety consequences. Tile damage was defined as a maintenance problem only. Each time they replaced the heat tiles and it was ready to go again. So the outcome was that one day at Columbia reentry into the earth’s atmosphere the orbiter broke into parts… and the flight data indicated that foam debris hits on the wing at the moment of launch had created a large hole in the wing. The heat of reentry started a fire and the shuttle disintegrated…there was a history of early warning signs that were misinterpreted or ignored until it was too late.

If events like mini-flash crashes and the fake tweet crash occur but do not cause immediate catastrophic damage, then investors may start to think that they are just part of the fabric of the market.  But these events are warning signs, just like the heat tiles that kept falling off the Columbia.  These warning signs are telling us about the deep structural flaws that are now inherent in the stock market.  Unfortunately, it appears the market is normalizing these deviants and setting us up to get hit by a much more damaging event in the near future