Wes Moss: How robots run the stock market

Certified financial planner Wes Moss provides personal finance advice and accessible investment strategies. His guest post appears here Monday mornings.

If Oliver Stone ever makes another movie about the financial industry, maybe he should call it, “Wall Street Three: Rise of the Machines.”

Yes, robots have taken over the stock market. You’ve seen their influence in the six 400-plus-point moves we’ve seen the past few weeks.

Wes-Moss-032011-USE-THIS-VERSIONMore than 70 percent of all market activity is traceable to “Algo trading,” “High Frequency Trading (HTF)” or “robo-trading.” These are computer-driven trades based on sophisticated mathematical formulas or algorithms that try to recognize various market patterns in the market.

One program, “Lexicon,” scans press releases, news articles, earnings reports and minute-by-minute economic data. It then uses that input to make instant “buy” or “sell” decisions. Instead of a human interpreting the information, a computer is crunching numbers and trading in nano-seconds.

HFT programs are designed to disguise large orders. Let’s say a large mutual fund company wants to sell a million shares of a particular stock. Dumping that many shares at once could drive down its price. So HFTs break up one giant order into thousands of much smaller trades and spreads them out over time in order to maintain the stock’s price while the fund unloads its shares.

(Get this: There are also Algos designed to detect an HTF.)

This is great for a billion-dollar pension and mutual fund, but where does it leave you? The power of the machines means the decisions you and I make with our regular 401(k) contributions — what to buy, what to sell — have very little impact on the market.

Yet, the basics of economics still apply

We’re no match for a computer-driven program executing 1,000 trades per minute — a program that can read the news and place 500 trades in the time it takes you to click your computer’s mouse.

The machines drive trading direction and exacerbate the market’s ups and downs, like during its recent roller-coaster ride. It was likely responsible for the May 2010 “flash crash,” when the Dow dropped 900 points in mere minutes.

But here’s the deal. The market still ultimately rises and falls on the timeless basics: corporate profits and underlying economic growth.

If we see growth here in America, and companies like Coca-Cola and Apple continue to sell more and more product, then guess what? The computers will pick up on that. The same programs that have exaggerated the market’s recent downward moves can just as easily push it to new heights.

Despite the Rise of the Machines, my advice remains the same: Be patient. It is foolish to constantly jump in and out of the market in an attempt to time things perfectly, especially against billion-dollar robot-trading machines. Such efforts almost always result in lost gains. (See my recent post on this topic.)

Setting an investment strategy and sticking to it is wise. And wisdom is an advantage humans will always have over machines.

– By Wes Moss, for Atlanta Bargain Hunter

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3 comments Add your comment

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just saying

August 22nd, 2011
9:14 am

Either ban trades by this software or tax the trades made by these software systems at 95%. This is not capitalism, it is automated gambling at the expense of the individual investor.

H.E.B

August 22nd, 2011
10:32 am

Just put a 48 hour hold on all buy orders.Date and time stamp each order and it must be held 48 hours before it could be sold. If their computers are so good they should be able to predict what a stock will do in two days as easy as what it will do in two seconds.