The Machines Rule Us Now – A Lesson in the Stock Market

Yesterday was a very interesting day in the finance world.  It was the perfect duopoly – terrible fake news and great positive news.

First, the tweet seen around the world:

Fake AP News Tweet

 

Then, a slew of positive economic news:

  • Positive Earnings Season
  • Housing Recovery Data
  • Apple Boosting it’s Dividend

And in the end, the day ended like this:

SP 500 Chart 4-23-2013

 

Crazy stuff…

But what does it really mean?  It just continues to show that the machines rule us all.

 

Black Swan Event: April 22 Fake Tweet Flash Crash

I’ve been predicting since early this year that black swan events are on the horizon.  And this had the potential to be a big one.  In seconds, volume skyrocketed and a massive sell-off occurred across all sectores.  It quickly recovered, but it points to one simple conclusion – the machines are trading massive amounts of stock on Wall Street, based on “news”.

In essence, someone (or multiple people), have hooked up their trading computers to Twitter.  Sure, you want to be able to trade quickly on economic news, or even if this Tweet was reliable, you’d want to act before others rush to the doors.  Remember, milliseconds count in this game.

The trouble is, what happens when the Tweet is fake?  Well, a real rush to the doors for a fake reason.

The writing on the wall is even scarier because it would have only taken one or two more supercomputer trades to trigger an even bigger sell off.

Look at it this way:

  • Level 1: Experimental High Speed Trading (HST) looks at ever growing number of indicators, including Twitter and Social Media – Players: Maybe 5-10
  • Level 2: Cutting Edge Live HST Programs already integrate real time economic indicators and news feeds – Players: Maybe 5-10, all Major Financial Institutions
  • Level 3: “Regular” HST, which everybody does now, looks at live market data to make trades – Players: Every Wall Street and Off-Wall Street Financial Institution

In this flash crash, we probably saw trades from Level 1, and maybe a few players in Level 2.  However, as these players made huge market movements, Level 3 players (i.e. everybody else), could have started initiating their trading programs, perpetuating an even deeper sell-off, and potentially a trading halt.

Then, real chaos would have ensued upon starting up again:

  • Would trades be canceled?
  • Would these algorithms rush to buy oversold stocks?

It would have been a real mess.  Luckily it wasn’t, and maybe (just maybe), something was learned from the first Flash Crash, but the bottom line is that the machines rule us now, and control billions of dollars.

 

In Lighter News, Ride The Bull

On the flip side, economic news is reinforcing several of my predictions earlier this year:

Both of these ideas are continually being proven, and hopefully they will continue to play out as expected.

Stocks and earnings are continuing to grow.  A big potential roadblock to this is the sequester, the effects of which are just starting to hit main street.  I see this as the biggest potential threat to growth for the remainder of the year, and sell in May and go away might bode well.

You are already hearing the news from the FAA, which is reporting delays in flights across the US.  This is just one example of how this will hurt corporate earnings.  Millions of workers across the countries are going to get effective pay cuts, which will hurt consumer spending.  However, the effects of this should be more short-term than long-term, so I still stand by my long-term bull market belief.

As for housing, I think the same rules apply.  Housing continues to be an economic bright spot, and if people are buying now (even with the potential sequester cuts), they don’t have too much fear in their income levels dropping.  Plus, with interest rates so slow, and supply constricting, it will make prices rise across the country.

What are your thoughts on yesterday’s events and high speed trading?  What about the economy as a whole?

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  • http://www.myfijourney.com My Financial Independence Journey

    I’ve always been a bit leery of algorithmic trading. And this just reinforces my suspicions. On the other hand, I’m a realist and don’t think that the algos are ever going to go away, so events like this will probably start becoming the norm rather than black swans.

    As for the sequester, I think that the stock market will probably keep going up for a while. The market has been pretty unhinged from reality for a while. Eventually the market will have to correct. Maybe sometime this year, but I’m not clairvoyant enough to call the top.

    • http://thecollegeinvestor.com Robert

      I’m a firm believer of sell in May and go away this year. I think we’re starting to see the impacts of the sequester, and I think consumer spending is going to take a beating in early summer. Hopefully you’re right, but I think the correction is coming sooner, rather than later.

  • http://mymoneycounselor.com Kurt @ Money Counselor

    I think HST is a disaster waiting to happen. Like most things overseen by bureaucrats, nothing will be done to remedy the situation until retail investors have been fleeced (again).

    • http://thecollegeinvestor.com Robert

      How many fleecings does it take? Especially since members of Congress play by their own investing rules!

  • http://www.frugalrules.com/ John Schmoll

    Like MFIJ stated, I think this is simply pointing towards things like this becoming the norm. I had seen this going on yesterday and thinking what on earth is going on. I think HFT trading is likely here to stay and it does cause some concerns, but I don’t know what can be done about it. Going back to the Flash Crash, Nasdaq did end up cancelling a lot of the trades that took place…though not all of them.

  • http://www.bluecollarworkman.com TB at BlueCollarWorkman

    Haha, and this is exactly why I invest my money and leave it alone. Maybe next time I could try to buy up stock during a black swan thing.

  • http://www.moneybeagle.com/ Money Beagle

    I hate HST and the entire idea of it, but I also don’t like traffic lights that change because of what traffic cameras ‘see’. i don’t have a problem with technology, but when it’s designed in ways that works against the majority of people, I oppose it. HST is not for the benefit of 97% of market participants, it’s for hedge funds, rich traders, and investment banks.

  • http://www.debtroundup.com Grayson @ Debt Roundup

    High Speed Trading is a train wreck that is unavoidable. There are too many factors when dealing with news that shouldn’t be used to trade. This just proves it. Anyone can post news to affect the stock market and computers don’t have the human thought process. It can’t distinguish between sarcasm and real thought.

    • http://thecollegeinvestor.com Robert

      That’s the key point – computers can’t distinguish, and I think that’s what happened here. But maybe in a few years, they’ll be able to, then it could be really scary.

  • http://retireby40.org retirebyforty

    My 10% trailing stop for GE kicked in. I’m sure many people had the same issue. I like trailing stop order, but it sucks to have fake news causing the problem.

    • http://thecollegeinvestor.com Robert

      That sucks, but it illustrates the point of how damaging these situations can be.

  • http://frugalguruguide.com/articles/ Jenny @ Frugal Guru Guide

    What does it really mean? Wall Street is THAT scared of a Biden presidency. :P

  • http://www.thefrugaltoad.com Paul @ The Frugal Toad

    I was just reading that the FSOC will release recommendations to deal with the threat HST poses to the stability of markets. Lets hope Congress takes action! Something else I learned was that there is a growing threat of “dark pools” or trading systems not open to the public that are potentially creating large amounts of risk that are basically unregulated. After 6 + Trillion Dollars in tax payer bailout money Wall Street is right back at it!