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December 10, 2018

The Truth Behind the Market’s Crazy Moves


If you thought the Dow Jones Industrials Average gapping down at the open yesterday, then dropping a heart-stopping 785 points, and then rallying back 709 points to close down only 79.40 points was normal, you might be right.

As abnormal as that sounds, it’s not unusual for equity markets to make intraday moves like that.

And while it’s not unusual, the truth about how it happens is frightening.

Here’s what’s happening regularly in the markets, why it’s so frightening, and how it affects you…

It’s the “Bots”


The Dow’s swing yesterday totaled 1,494 points. In percentage terms, that’s almost a 6% move.

That’s not investors deciding at the open to sell, sell, sell, then calming down and deciding at the end of the day to buy, buy, buy.

Investors don’t invest that way.

In fact, traders don’t even trade that way.

What that is, for the most part, is high-frequency trading (HFT) triggered selling on top of investor selling at the open. That petered out around 11:30 EST, followed by HFT triggered buying, which lasted until 2:00 pm, and was then followed by investors and traders selling until 2:45 pm, followed by another burst of HFT-triggered buying that got investors to buy and short-selling traders to buy to cover their wrong-way bets, all the way into the close.

For sure, there are investors and traders at work, all day. But the big turns and a lot of follow-on momentum selling and buying is caused by HFT gaming.

Investors were fearful at the open yesterday. News that the daughter of Huawei Technology’s founder, Meng Wanzhou, who is Huawei’s CFO, was arrested in Canada on behalf of U.S. authorities, put hopes that the U.S. and China might come to terms over tariff tiffs into a tailspin.

Sell orders flooded exchanges before the open. Stocks gapped lower and sank in early trading.

Besides initial investor selling and traders shorting stocks, HFT algorithms automatically see there are sell orders coming down the wires to be executed and jump ahead of those sell orders.

Because they can.

Because their servers read incoming orders, they can jump ahead of them because of their speedy access to exchanges’ servers.

That means when investors’ and traders’ sell orders reach exchanges for execution, they often must take a lower price. Because a lot of those orders are market orders that knock prices lower, which scares investors more, which causes more selling, which HFT “bots” front run again, causing downward momentum.

That’s what happened recently – and it happens a lot.  

Machine Manipulation


Then things settled down in the afternoon and stocks recovered a bit and traded sideways.

That’s because the HFT bots couldn’t move things much.

That is, until they saw the late selling from 2:00 pm until about 2:45.

When the bots saw that 45-minute bout of selling peter out, they knew traders were short, anticipating a selloff into the close, and nervous investors were worried there would be more selling into the close.

Of course, that’s game on time for the bots.

HFT algorithms start sending buy orders down to exchanges. Other bots see there are buy orders coming in, not at higher prices, but at the current price of most stocks.

Investors and traders see those orders accumulating, thinking those orders will step up and buy stock at a higher price, and they start buying.

That’s all it takes.

The bots keep sending down bids and investors keep buying as prices start rising quickly.

Short covering sends stocks a lot higher, quickly, and bots keep bidding up stocks.

They’re always buying just ahead of investors coming in with their buy orders, because they can see their orders coming and front run them and, of course, investors and traders then must pay up a penny (or sometimes a lot more) to get their fills.

That’s what caused the late rally yesterday.

That’s how the game is played.

That’s how the Dow can swing 1,500 points in a day, any day.

It’s frightening because machines are manipulating investors. It’s dangerous for America’s capital markets.

But, it’s reality. It’s what regulators have allowed.

The only sensible thing regular investors can do is sit tight and see where things end up, which could be disastrous.

Or, they can use stops and get taken out of positions by the bots, and watch stocks recover, which can be disastrous.

Or, they can trade up and down and around the swinging markets, which is really hard to do.

Or, they can call their Congressmen and Senators and complain that the SEC has allowed America’s capital markets to be hijacked by a bunch of greedy gamers.

Courtesy Shah Gilani, Wall Street Insights & Indictments (More by Shah here)   
The views and opinions expressed herein are the author's own, and do not necessarily reflect those of EconMatters.

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