The dangers of an automated stock exchange

Some years ago, there was a lovely cartoon that showed snow falling outside a stockbroker’s office in New York. One broker nonchalantly says to his friend ”snow is falling”. Immediately, in frenzied unison, all of the other brokers start screaming “Snow is falling-sell snow…sell!”

This neatly captures the herd mentality that pervades financial markets. Because most players in the financial services industry tend to do what the rest do, their actions get magnified.

Take the instances this week where the rand first rose on the rumour that President Jacob Zuma had resigned, only to fall back heavily when it was revealed that he hadn’t.

Or the large drop in the share prices of Aspen and many property stocks, catalyzed by the possibility that Viceroy Research, the company that had exposed Steinhoff’s financial irregularities in December 2017, was about to issue similar, damning research on these companies.

Rather than sit back and take a measured approach to this, market participants have been selling, just to make sure they are first in line if and when bad news materializes. Viceroy Research will not be drawn on whether or not they have prepared, or are even going to prepare any research on the aforementioned companies.

This if course highlights some of the dangers of automated trading on financial markets. It has been estimated that more than half of all trades that take place on the New York Stock Exchange are automated; in other words, they don’t rely on human input to make the call on whether to buy or sell. They use algorithms to discern patterns in share price activity and act on them. It is thus easy to see why large price movements can occur without any apparent rationale.

One of the craziest signals this week was the aborted satellite launch from Cape Canaveral, using a Falcon 9 rocket. The whereabouts of the satellite, codenamed “Zuma”, were unknown after the initial separation, with most observers speculating that “Zuma was lost”.

Given the convergence of news media these days, it didn’t take long before that little snippet made it into the South African financial markets as well. Oh and if you were wondering why a US space satellite was codenamed Zuma, it was named after a beach in Malibu, Los Angeles County, California.

Chris Gilmour is an investment analyst

Be the first to comment on "The dangers of an automated stock exchange"

Leave a comment