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Wizened Wall Streeters say that you’ll have more investing success if you remove emotion from your buy and sell decisions. Perhaps the most emotionless approach is program trading.
This is a generic term used to describe trading in stocks, options and futures based on price relationships and not on the underlying fundamental strength or weakness of the company or index. If you see the DOW suddenly turn from plus-50 to minus-50 without big-time breaking news, it’s probably the result of program selling. The same goes if a declining index spurts into positive territory within the span of a few minutes; that’s likely a buy program hitting the market.
That’s what happened Thursday, November 20, 2003 in the final hour of trading. The DOW and NASDAQ were nicely green when a sell program hit. Down they went, and by the close the DOW was down 71 and the NASDAQ off 17.
It’s completely legal and performed by all the major institutions. They have the capability to dump millions of shares in a sell program; conversely, they’ll grab millions of shares in a buy program when they are in an acquisitive mood.
The trades are usually triggered automatically at specific price or technical levels like the 50-day moving average or DOW 10,000. The trigger point is often chosen many days earlier. The computer does the work. It’s the ideal “set it and forget it” style of investing.
Many times program trading sets the stage for a strong or weak open to a trading session at the NYSE or NASDAQ. If you read in our e-mails that the S&P futures are soaring well ahead of fair value in pre-market activity, the odds are that institutions will automatically sell the futures at the open and buy the underlying stocks to set the stage for a big gap higher. The same can happen in reverse if the futures are collapsing.
If you hear a reporter on a financial station talk about “rotation” from one sector to another, he’s probably referring to one or a series of programmed moves. In that case, the institutions have picked a certain price level to shift from, say, cyclicals to small caps. The swap usually impacts most of the stocks in those sectors.
The sudden appearance of a buy program or two can also create a “short squeeze” in which traders decide to buy shares of stock to cover an eroding short position. The increased buying pressure, adding to the programmed buying, can dramatically increase the upward momentum.
Dueling buy and sell programs were staples of the 1990s bull market when volatility often ruled the exchanges. Even today, as much as 30% of NYSE daily activity is pegged to program trading. Whenever the market begins to rally, you may see more of this volatile action.
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