Black Box Trading: Computers Taking Over Wall Street?

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(List compiled by Becca Lipman.)

In the "Robots that Take Over the World" department, we revisit the controversial topic of high frequency trading, black box trading, or algo-trading - the practice of using complex algorithm programs by hedge funds.

Together, algo-trading is responsible for nearly 70% of the trading done on Wall Street.

The gist of how and why black box trading works: If a hedge fund's client wished to sell off $500M worth of Google stock all at once, the markets would notice and price may fall, to the despair of hedge fund and client.

To avoid these consequences, hedge funds use algorithms that break down the stocks into several smaller transactions and sell them through several more discreet channels. 

But it's a dog-eat-dog world out there: Competitors have algorithms in place to detect other algorithms trading large quantities of stock. Thus, when Firm B notices Firm A trading Google in bulk, Firm B can take action, perhaps by taking a short position on the stock.

Hedge funds are increasingly reliant on this type of trading to move large amounts of stocks without causing a panic or a price reaction on the market. Conversely, they are becoming a key player in market espionage.  

Naturally, the market becomes more volatile when algorithms, in complete miscommunication with one another, are calling the shots. High Frequency trading is even said to be responsible for the 2010 "flash crash of 2:45" when 9% of the market inexplicably disappeared for 20 minutes. The last few weeks have been no exception:

"Gary Wedbush, executive vice president and head of capital markets at Wedbush Securities, told Bloomberg News on Friday that more than 80% of the firm's orders since Aug. 1 have come from high-frequency trading clients, at five times the typical volume… Experts don't blame high-frequency trading entirely for the market's nauseating moves, but they say it certainly exacerbates them." (via CNN Money)   

Kevin Slavin argues in a TED presentation that we are increasingly writing algorithmic programs to be so automated, complex, and lacking in human oversight that the implications are no longer entirely within our control. "We're writing these things that we can no longer read. And we've rendered something illegible. And we've lost the sense of what's actually happening in this world that we've made."

Whether Black Box trading is a path to a financial Matrix or not, the prevalence or algorithms in the market cannot be ignored. An investment firm reported to CNBC, “some of the stocks most commonly held by average investors are also the ones most often used in high-frequency trading and thus subject to high levels of volatility."

Not so sure you want to take on these lightning fast computer traders? If you want to avoid them, have a look at the following list of stocks most commonly traded by high frequency trading programs.

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The top 10 by market cap:

1. Exxon Mobil Corporation (XOM): Major Integrated Oil & Gas Industry. Market cap of $350.07B. Current price at $73.82. The stock is currently stuck in a downtrend, trading -5.46% below its SMA20, -6.82% below its SMA50, and -5.61% below its SMA200. The stock has performed poorly over the last month, losing 11.87%.

2. Apple Inc. (AAPL): Personal Computers Industry. Market cap of $349.50B. Current price at $382.88. Might be undervalued at current levels, with a PEG ratio at 0.72, and P/FCF ratio at 12.01. The stock has gained 51.34% over the last year.

3. Microsoft Corporation (MSFT): Application Software Industry. Market cap of $210.29B. Current price at $25.29. Might be undervalued at current levels, with a PEG ratio at 0.89, and P/FCF ratio at 10.81. The stock has gained 5.37% over the last year.

4. General Electric Co. (GE): Diversified Machinery Industry. Market cap of $168.33B. Current price at $16.28. Might be undervalued at current levels, with a PEG ratio at 0.89, and P/FCF ratio at 10.68. The stock is currently stuck in a downtrend, trading -6.74% below its SMA20, -10.11% below its SMA50, and -12.57% below its SMA200. The stock has performed poorly over the last month, losing 14.3%.

5. AT&T, Inc. (T): Telecom Services Industry. Market cap of $167.23B. Current price at $28.67. The stock has gained 11.76% over the last year.

6. JPMorgan Chase & Co. (JPM): Money Center Banks Industry. Market cap of $140.01B. Current price at $36.71. The stock is currently stuck in a downtrend, trading -6.32% below its SMA20, -8.02% below its SMA50, and -13.19% below its SMA200. The stock has performed poorly over the last month, losing 11.%.

7. Pfizer Inc. (PFE): Drug Manufacturers Industry. Market cap of $139.35B. Current price at $18.25. The stock has gained 15.75% over the last year.

8. Oracle Corp. (ORCL): Application Software Industry. Market cap of $138.74B. Current price at $27.3. The stock is currently stuck in a downtrend, trading -8.97% below its SMA20, -12.79% below its SMA50, and -13.89% below its SMA200. The stock has performed poorly over the last month, losing 14.54%.

9. Wells Fargo & Company (WFC): Money Center Banks Industry. Market cap of $127.40B. Current price at $24.79. Might be undervalued at current levels, with a PEG ratio at 0.72, and P/FCF ratio at 4.56. The stock is currently stuck in a downtrend, trading -7.52% below its SMA20, -8.19% below its SMA50, and -15.3% below its SMA200. The stock has performed poorly over the last month, losing 11.16%.

10. Intel Corporation (INTC): Semiconductor Industry. Market cap of $108.43B. Current price at $20.77. Offers a good dividend, and appears to have good liquidity to back it up--dividend yield at 4.07%, current ratio at 2.23, and quick ratio at 1.84. The stock has gained 11.56% over the last year.



The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of The NASDAQ OMX Group, Inc.



This article appears in: Investing , Investing Ideas , Stocks


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