Program Trading

[OldShooter]

I am not hampered by any facts, but I wonder about the extent that program trading is contributing to this market craziness. It will be interesting to see the analysis when the dust settles.

Personally, I think program trading has no public value and should be stopped. I liked Bloomberg's idea of a very small tax per transaction. That would be enough to shut most of it down.

Anyone looking for reading in quarantine, try Michael Lewis' "Flash Boys." It's a good and very readable introduction to program trading.

 

[LOL!]

I've read all the books and I don't care about program trading. I don't care much about volatility except that it presents opportunities to me. I think mostly program traders are playing among themselves and retail investors are not really hurt at all by their actions and are often helped.

 

[Dtail]

My last few years of work in supporting the Hedge Funds, some of the most successful funds had mainly program trading.
Is it fair or not? Not sure.

 

[OldShooter]

I'm not thinking of it from a fairness standpoint and the term "Program Trading" paints with a pretty broad brush, but certainly there can be algorithms that in aggregate if not individually make volatility worse.

& I don't think volatility overall does society any good. Sure, having more volatility is like having more slot machines for traders to play, but I don't see that as a social good. I think volatility scares people and reinforces the idea that investing is gambling -- resulting overall in less investment and less saving. That, in turn, leads to underfunded retirements.

 

[NW-Bound]

I've read all the books and I don't care about program trading. I don't care much about volatility except that it presents opportunities to me. I think mostly program traders are playing among themselves and retail investors are not really hurt at all by their actions and are often helped.

+1

I'm not thinking of it from a fairness standpoint and the term "Program Trading" paints with a pretty broad brush, but certainly there can be algorithms that in aggregate if not individually make volatility worse.

& I don't think volatility overall does society any good. Sure, having more volatility is like having more slot machines for traders to play, but I don't see that as a social good. I think volatility scares people and reinforces the idea that investing is gambling -- resulting overall in less investment and less saving. That, in turn, leads to underfunded retirements.

On the other hand, "scary stock market" may become more fairly valued, and the market becomes more stable when investors no longer chase hot stocks.

 

[Clone]

Is there any logical explanation how we can have these big swings in the market? It seems like every other day it is up 4% or down 4% (roughly). Is this just the market trying to shake out the overly optimistic and overly pessimistic to find where it really belongs? I feel like you need to wait for the last 20 minutes of the day to make a buy or sell on mutual funds because it could move a lot.

 

[OldShooter]

Is there any logical explanation how we can have these big swings in the market? ...

Almost certainly not. That won't stop the press from pontificating, using the word "investors" instead of the more appropriate "speculators" or "traders." Some of these pieces will sound like the writer actually knows what he is talking about. But with a couple of billion shares traded it is beyond impossible that anyone could talk to enough traders to even begin to understand. And the traders aren't talking.

If there actually is someone who understands why these moves happen, you can be sure that they are not going to tell us.

From past situations it appears that the exchanges do have ways to estimate program trading volume separate from "real" trading volume.

Edit: More on flash crashes: https://en.wikipedia.org/wiki/Flash_crash

 

[BeachOrCity]

I don’t know how we could possibly get rid of it?
But while I can’t cite a source I am pretty sure this was studied and the answer is an emphatic yes.
It’s the primary reason behind the 1987 black Monday crash and the resulting circuit breakers put in place.

 

[pb4uski]

I totally agree. It seems to me that all program trading results in is additional volatility that isn't a faithful representation of investor sentiment.

I like the idea of a tax on net gains for any purchases held less than a day... say double the ordinary rate... to nip it in the bud. Or as Vanguard attempts with their frequent trading policy... if you sell a stock then you can't rebuy it for x days to discourage speculating and encourage long-term investing.

From a public policy perspective we want to encourage investing rather than trading.

As I've written elsewhere on the forum, for the same reason, I would prohibit short selling stocks and bonds. Where else other than the stock and bond markets can someone sell an asset that they do not own? It encourages people to invest in failure... I think from a public policy perspective we should encourage investing in success instead.

Volatility is part of what has made me more bearish on equities than I am bullish on American businesses. Speculative trading is one of the root causes of bubbles because prices get disconnected from underlying economic value.

 

[LOL!]

...
From a public policy perspective we want to encourage investing rather than trading.

As I've written elsewhere on the forum, for the same reason, I would prohibit short selling stocks and bonds. Where else other than the stock and bond markets can someone sell an asset that they do not own? It encourages people to invest in failure... I think from a public policy perspective we should encourage investing in success instead.

Volatility is part of what has made me more bearish on equities than I am bullish on American businesses. Speculative trading is one of the root causes of bubbles because prices get disconnected from underlying economic value.

I have the complete opposite opinion. Without speculators and risk-takers there would be no stock markets at all. Businesses would not even be able to raise capital like they can today. Mom & pop investors would have too little money to invest and quite a bit of risk aversion so they wouldn't invest. Only the chance of cashing in big is what drives many people to invest. Just look at how much effort goes into trying to sell investments to the non-speculators and non-risk takers. There is an entire industry of Edward Jones, Fisher Investments, American Funds, and so on that simply pumps, pumps, pumps, and skims, skims, skims money away from people.

Without the risk takers and gamblers, everyone would be stuck in CDs and savings accounts.

And I like Flash Crashes myself. They are an opportunity to buy lower than expected. Only folks who sell are adversely affected by a Flash Crash, right?

 

[FIRE'd@51]

Personally, I think program trading has no public value and should be stopped.

Program trading also includes the purchase or sale of entire portfolios at a particular point in time (e.g. at the market close). This is very useful for mutual funds and pension funds that want to buy indexes. It also keeps futures such as those on the S&P 500 trading very close to fair value via arbitrage.

 

[donheff]

Program trading also includes the purchase or sale of entire portfolios at a particular point in time (e.g. at the market close). This is very useful for mutual funds and pension funds that want to buy indexes. It also keeps futures such as those on the S&P 500 trading very close to fair value via arbitrage.

I hadn't thought of it but I rely on this to sell funds at optimal times. I have no ETFs in taxable, only index funds.

 

[OldShooter]

Program trading also includes the purchase or sale of entire portfolios at a particular point in time (e.g. at the market close). This is very useful for mutual funds and pension funds that want to buy indexes. It also keeps futures such as those on the S&P 500 trading very close to fair value via arbitrage.

Sorry, I am guilty of sloppy work. I should have defined the term. I will try, imperfectly, now: "Program Trading" is automated trading based on price and volume movements without regard to the characteristics of the underlying security. It can be identified by patterns of buying and selling with very fast reactions to price and volume events, as evidenced by the program traders' efforts to minimize the transmission delay between the market event and their computers.

I don’t know how we could possibly get rid of it? ...

... I like the idea of a tax on net gains for any purchases held less than a day... say double the ordinary rate... to nip it in the bud. ...

You'd have to deal with the symptoms, because it would be very hard to look inside the heads of the programmers. One way that I think would work is to have a simple transaction tax of, for example, 10bps. Too small to bother investors and "real" traders but death for someone who wants to make thousands of transactions a day and hopes for pennies of profit on each.

From a public policy perspective we want to encourage investing rather than trading.

I have the complete opposite opinion. Without speculators and risk-takers there would be no stock markets at all. ...
Without the risk takers and gamblers, everyone would be stuck in CDs and savings accounts..

I would say you two guys are in agreement. Stable markets do require the speculators and risk takers. IMO this is especially true as the majority of stocks are held by passive investors. It is @LOL!'s favorite people who provide the price discovery.

The good news is that these folks will never go away for the same reason that the casinos and lotteries will never go out of business. Evolution has wired us humans to think that we are exceptional and to be optimistic. Both are survival traits.

Only folks who sell are adversely affected by a Flash Crash, right?

Nope! The collateral damage to society is the people who are terrified of the markets and who "invest" all of their retirement savings in low-yielding fixed income products like savings accounts, "stable value" funds, etc. This fear of volatility deprives them of the gains that equities have historically provided and of a much more comfortable retirement than they will be getting.

 

[audreyh1]

Is there any logical explanation how we can have these big swings in the market? It seems like every other day it is up 4% or down 4% (roughly). Is this just the market trying to shake out the overly optimistic and overly pessimistic to find where it really belongs? I feel like you need to wait for the last 20 minutes of the day to make a buy or sell on mutual funds because it could move a lot.

The logical explanation is that there are lots of panicked traders and investors. Volatility goes way up during periods of stress like this. The slightest rumor causes outsized reactions. Not to mention the number of investors using margin or other leverage that have been forced to liquidate.

 

[Montecfo]

But markets are "efficient" right?

OldShooter,

I think your definition of program trading is interesting. It does help to have a better discussion if we define the terms. I also think that index buyers result in stock purchases without regard to underlying fundamentals. They may not be using automated processes to do that, but the firms that put together the indices and the ETFs certainly do. I think they have to due to volumes involved. They also have an incentive to do so to improve the reported returns on their respective financial vehicles.

A final thought is this: if you believe markets are "efficient", I am not sure how program traders can be the villains.

Just a few thoughts.