Welcome to the end of the week and another edition of Happy Hour! Just sit back, relax, and enjoy your end of the week roundup of all things interesting in the land of money.
There was a lot of drama this week thanks to a fake Associated Press tweet claimed $200 billion in market cap in a matter of minutes. A well-respected news organization getting hacked is big news. A bigger concern is the how the market reacted to a fake story in large part due to computerized trading.
High Frequency Trading (HFT) involves computers that use algorithms to place thousands of orders in milliseconds based on specific parameters. The argument HFT firms use is that it provides liquidity to the markets. Which is arguable, based on what we saw this week after the AP hacked tweet.
To be clear, a coding error didn’t cause this weeks flash crash. But it’s the biggest concern going forward, having already been a cause of most minor crashes so far.
The simple version goes like this: HFT uses code written by humans to decipher what’s going on in the markets and outside the markets. It uses that information to make a bunch of trades or stop trading altogether.
Code, in general, is perfect. It’s built around a logical set of yes and no answers to come to a conclusion. Until someone makes a mess of it. Which happens all to often because the programmer is human and advanced software programs and algorithms are built around thousands, if not, millions of lines of code. That’s a lot of opportunity to make a mistake.
Just think about how many errors we find in code on a given day. If you own a computer you have a good idea. With Windows, browsers, Java, Adobe, and all the other software you use, how many updates and security patches have you done?
There is a big difference between software and HFT algorithms though. Usually software is updated for one of two reasons: either the millions of product users experience a similar problem or some nice hacker finds a security hole and lets the company know. Either way, updates occur because users are reporting errors. That’s despite the rigorous error checking done by the software company.
With HFT, there is only one user for each piece of code – the trading firm. That significantly reduces the chance of finding errors. And the idea that the firms error checking is somehow better than big software companies, is laughable?
So how error free is that perfectly crafted algorithm? How secure was your Windows operating system when you bought it? How many security patches have you downloaded since?
Until the SEC comes to its senses, the best way to protect yourself – do not use stop orders. Instead, set price alerts through your online broker. At least then you can figure out why the price fell and what to do next.
Since the frequency of these little crashes are increasing, I wonder if we’re better off, holding some cash and putting buy orders in at ridiculously low prices. At least then we can profit from it, as long as the SEC allows this nonsense.
Just wanted to apologize for the technical issues at the beginning of the week. If you tried to visit the site, you were probably met with some error messages.
Seems some gremlins got into the server, threw a kegger, spilled beer, and fried the server connection. It really got out of hand. Anyways, we scared off the little rascals and everything is back to normal.
At least, that’s the story we’re sticking to.
- Is the Federal Reserve Insane? – a great article pointing out past Fed action and if the current policy is causing another bubble.
- Big Market Drops Happen More Often Than You Think – Interesting and I’d add having a plan to take advantage of these big market drops.
- Stock Analysts Tell All! – The number one reason to take analyst estimates with a grain a salt. You’re better off doing your own research and just ignoring them.
- For Bond Risks, Look Forward, Not Back – why past results doesn’t matter for bonds.
- Nine Rarely Heard Buffett Quotes – a great list worth reading.