Behind the stock market headlines...
These days I get a kick out of reading the headlines on Yahoo! Finance or any other financial website after the market has closed. Here are some headlines the past week after the trading day ends:
- Stocks Slip as caution about the economy returns
- Financials Rally Over Relief on Jobs Report
- Stocks Drop as Fear Returns over Economic Data
- Stocks Gain as Economic Fears Ease
The thing that tickles me to death is that people actually believe that these are the reasons the stock market moves this way. Over a two week period there were headlines that read "European Debt causes stock market to falter," while the next day it says "Markets shrug off European Debt to go higher" and three days later it says "Stock Market Falls over European Debt fears." It seems there always has to be a reason that the market has moved, which technically is the truth as someone has to move the markets for some reason, but these days it seems that those news headlines affect the markets less and less. There are numerous reports out that the ‘small investor’ has not been investing their money into the stock markets during the whole rally and subsequent channeling which you can see here and here .
What the average investor may or may not know is what goes on behind the scenes in today’s stock market. The stock market has long been hiring the best and brightest students from top schools to develop what’s termed ‘Black Boxes’ which trade stocks based on algorithms in microseconds. This causes high volume in what ordinarily would not be such a high volume trading session.
For the average investor looking to foray into trading equities in the stock market this provides a very daunting proposition – how are they to compete against these juggernauts trading millions upon millions of shares a day?
Some firms that offer online trading are stepping up and offering items to where you can create your own algorithms, although probably not to the level a Goldman Sachs programmer can do. Working for E*TRADE Financial a while ago there was an add on to where you could make your own algorithmic equations in excel and have their high-frequency trading system, Power E*TRADE Pro, place the trades for you when your algorithms told you to do so.
A very simplistic example is that you can place a trade which reads if the DOW hits 9000, buy 1000 shares of GOOG (Google, Inc.). If you know a few things about technical analysis, then you can setup a trade which will execute if the MACD convergence line crosses the divergence line, the Fibonacci regression line has broken through on above average volume, the top of the Fibonacci Arc has been hit, or a certain pattern (cup and handle) has been recognized. If you want to know more about these then feel free to shoot me an e-mail.
In August 2009 the TABB Group released a report which said that firms that did algorithmic trading took in roughly $21 billion profits in 2008! Obviously something is working right for these companies who simply trade stocks all day long. There also has to be someone on the wrong side of those trades…see Greece, Italy and the always effervescent small traders.

So what does this mean to the Average Joe investing in the stock market? With over 70% (was estimated in 2009, now it’s supposedly north of 80%) of the trades being done with these ‘Black Boxes’ it means that eventually these companies’ profit margins will regress over time as everyone will know what algorithm sequence to trade with, and will render most technical analysis methods virtually unusable unless someone has a one-of-a-kind method. This has happened with popular charting tools and technical indicators. The Moving Average indicator hasn’t been effective for decades. This is also why Goldman and the other big boys are hiring the most talented and brightest people to build them one-of-a-kind machines.
It also means that just because there was a bad report, it’s probably not the reason the market is going lower. In reality it’s probably because a key algorithmic indicator was hit and the computer told it to sell off. Big firms don’t look at the news like they used to and say “OMG…Beige Book report had a negative outlook so sell sell sell!!” In contrast they let their programmers work and let the computer algorithms take over and automate the entire process. I just can’t help but thinking of the Terminator, machines interacting with machines (black boxes), all the while killing what’s left of the human population (small investors).
