How Split Second Program Trading Affects the Market

The New York Times reports on the type of split second program trading that led to United Airlines (UAUA) losing $1B in market capitalization in 12 minutes. The old bankruptcy story on the Sun-Sentinel newspaper website picked up by Google had already been widely disseminated by CNBC and others. More interesting is how program trading feeds on itself and its effects on retail investors.

Professor Andrew W. Lo [M.I.T.] started looking for correlations between the “emotional context” of stories in The Wall Street Journal and the stock market. He assigned weighting to words such as bankrupt, anxiety and down. While Lo has been collaborating with Thomson Reuters (TRI) to develop trading tools, Dow Jones and Bloomberg have been developing their own offerings. Computer scientists and linguists are reaching beyond traditional news to track sentiment on blogs and social networks.

The objective of news related trading is to gain the first reaction advantage, leaving no time for human judgement. Luckily, Bloomberg’s premature obituary of Apple’s (AAPL) Steve Jobs was released after trading on August 17, 2008. Once news based program trading starts, the pace is exaggerated by momentum based program trading.

Aite Group consulting predicts that programmed trading will account for nearly 50% of the NYSE volume in 2010, up from 30% in 2006. Can program trading exist without naked shorting? Very sophisticated systems would need to be built to locate and commit delivery of the shares to be shorted in milliseconds. Is programmed trading why SEC Chairman Cox is dragging his feet on new regulations to combat naked shorting?

Programmed trading, news driven or otherwise, brings both risks and opportunities to retail investors. The relentless pressure on the financials is obvious. But, the potential for retail investors to buy in an air pocket or sell in a spike might not be. I’ve had limit orders take on opportunities that only lasted a moment or two.

No Disclosures.

Comments

[Iconoclast421:]

Right, I've also had some wild limit orders go through. Sometimes they dont even show up in the chart. Friday I had a limit order for MER @ 14.77. Sadly, it did not go through.

As for the google thing, I am looking for a screenshot of google's cache for that article they say "had never come across the item before". I bet it was in google's cache, and I bet someone has it.

And as for Income Security Advisors, they need to fire that moron who thought UAL went bankrupt this year. Something like this could bring the whole market down. Especially during times like these.

I would not be surprised if someone at google was buying PUTs on UAL...

2008 Sep 15 09:03 AM

[whidbey:]

Too connected! Too close! Any information, wrong or correct,but out of date is communicated in real time and acted upon without review or consideration. This shoot-from-the-hip mentality has its dangers, not the least of which is error, emotion, and intentional manipulation of the market. It is another indication that man-machine interface is critical and when lacking become its own threat to any system which has no limits to its variances. It will eat us alive in Wall Street one day, but we only noticed it in weapons controls, and in flight controls. But it is here everywhere and we should fear its consequences.

2008 Sep 15 10:09 AM

[nukldrager:]

whidbey, I agree as database capacity and processor speed continues to increase exponentially these "tools" mindlessly shape our lives. What comes after yottabyte?

2008 Sep 15 11:59 AM

[spdsuprdoc:]

Naked short selling should be halted regardless of whatever it takes. It allow institutions to gamble without buying the chips and should not only be illegal, but a felony. You MUST pay to play!!!

2008 Sep 15 06:22 PM

[Steven Hansen:]

the small investor is at a disadvantage to incidents such as UAUA false bankruptcy story.

but the source of the story has damaged UAUA and should be litigated out of existence. "i am sorry" just does not cut it.

2008 Sep 15 10:29 PM