By Corinne Speckert, TradeDecider.com
written on October 01, 2009 18:42, last update 6 months ago
Although program trading has been linked to past controversies, such as the 1987 stock market crash, it has been growing in popularity by not only large financial institutions, but also by average investors — now, accounting for around 30 to 46 percent of daily trading volume.
Program trading is essentially the simultaneous trading of large-volume securities, which typically consist of at least 15 stocks and have a total value exceeding $1 million.
Unlike other programs that work to assess a stock's value, program trading assesses stock prices based on buy and sell execution levels as opposed to fundamental or economic reasons such as dividends, growth prospects or interest rate movements.
These execution levels are based on the difference between the most active S&P 500 Index Futures Contract, minus its actual index, which is based on cash and ranges from $5 to -5 as its expiration date draws near.
The top players dictating these buy and sell signals along with the S&P 500 are the NYSE, Chicago Mercantile Exchange and the Chicago Board Options Exchange, which work by trading off each other's corresponding options.
Despite claims that program trading increased the market's volatility, it has prevailed, according to the Library of Economics and Liberty, due to three main factors.
- Investors learned that trading diversified portfolio securities as opposed to individual stocks can help reduce risk.
- Institutions are holding and trading higher fractions of equity.
- A decline in trading costs due to technological advances.
One misconception investors may have about program trading is that it's fully controlled by computers — this is not the case. Although program trades are executed by computers, the buy and sell decisions behind them are made by people who use these computers to aid their trading decisions.
Among the financial giants capitalizing on this technique are Goldman Sachs — the number one firm in program trading — Credit Suisse First Boston, UBS Securities, Barclays Capital and Morgan Stanley.
Program trading has been associated with multiple trading strategies, with index arbitrage being among the most controversial, as traders try to profit off price discrepancies between the stock and futures/options markets and has been used as a tool by institutions with large and diverse stock portfolios.
In response to claims against program trading, time limits for its use have been set by the NYSE, which limited computer-generated trading hours. Time limits can be found at http://www.nyse.com
Although the big guys have the power of arbitrage, average investors can still benefit off program trading by following the stock market. By being aware of how stocks are weighted — on buy
and sell
sides — and ensuring your actions are aligned with those of the majority of traders — you too, can be a dominant player in the program trading game.
So, if it's that easy why isn't every investor taking advantage of this powerful trading method?
That's because the strategies associated with program trading — as well as the powerful algorithms behind them — are unknown to most traders except those working in Wall Street, who aren't likely to share their golden goose. If you have the time to obediently watch the market, you can be successful, but most people don't have that time — leaving the mega giants to continue their domination trend.
Note: Because of my lack of experience in financial writing, Phillip Pham, the CEO of TradeDecider, Inc., did not credit my name for these writings. Should anyone have questions regarding the authorship of these writings, please contact Phillip Pham at (408) 693-9358 or through e-mail at dtprophet@yahoo.com and philip4av@gmail.com
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