Wall Street Is Close to Fully Bionic

I, for one, welcome our new computer overlords:

Investors and pundits are left clutching at straws to explain big moves in the stock market, such as attributing a June 8 bounce to rehashed comments from Nobel Prize-winning economist Paul Krugman. The difficulty in divining a fundamental explanation stems from a structural change in the U.S. stock market: The majority of stock trades now originate with fully automated “high frequency” funds, a phenomenon that has accelerated during the market turbulence of recent years because of the relative success of the strategy.
These funds employ no traders in the conventional sense. They employ no economists or chart trackers. Rather, programmers at funds such as those operated by Citadel Investment Group and Renaissance Technologies outfit computers with strategies based on obscure mathematical correlations. Then the machines trade in and out of stocks at light speed without human intervention, a departure from the “fundamental” investing model that dominated trading for the last century.
The growth of these funds is such that institutions whose names have never appeared in the newspaper are now trading hundreds of millions of shares a day. Major hedge funds that have put other strategies on ice are opening new funds devoted to high-frequency strategies and hiring the mathematicians and computer programmers that run them. Some of the fastest-growing market makers, such as Global Electronic Trading Company, or Getco, also use the automated strategies.
With the rise of these automated funds, the stock market is more prone than ever to large intraday moves with little or no fundamental catalyst. Computers don’t analyze the news (although some strategies use headlines as triggers) or seek to justify their buying and selling. Even in the relative quiet of the last three months, investors have often watched individual stocks or sectors move by 10% or more without explanation.

Posted by Eddy Elfenbein on June 18th, 2009 at 9:28 am

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