Programmed Trading

Michael Steinberg comments on programmed trading, questioning whether it has had any influence on the SEC’s slow and incomplete efforts to stop naked short selling. Sounds to me like that would be a conflict of interests, and if so, shouldn’t it be resolved in favor of the law? – Ilene

The New York Times “I Got the News Instantaneously, Oh Boy” 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 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 (TRIN) to develop trading tools, Dow Jones (NWS) 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 judgment. 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.