We’ve entered a new age of trading: Perception based high frequency trading.

It used to be some trader somewhere would try to get their hands on a new press release, or make a guess using out-of-band information about what a company or person was going to do. Based on that, they could figure out if a company was going to make money or have a killer product or continue to sort of plod along. These realities are still important and drive the majority of insider trading law, but whats a market to do when there’s a vacuum of information and innovation because the economy still sucks?

We trade on perception.

However it gets even more interesting than that. When the trade happens on perception, and not on actual fact, it generates much less movement than a stock going public or some company announcing a new contract. What we used to have were bots looking for stock trends and then buying a few hundred thousand shares to generate money on the resale. While this requires high speed access to the markets to both see the trend and execute the buy and sell, this is relatively simple. The stock would rise, the machines would buy, they would immediately sell, and make a few cents on the shares as the stock continued to rise.

Someone, somewhere realized the risk was proportional to how long the stock was held and by the volume of stock purchased. How do we get around that idea?

The machines got faster and the market started doing something new. The machines would buy less stock, sell it faster, and then wash, rinse, repeat. Big companies can do it because they pay for a subscription to the market rather than per trade. Suddenly, the trading volume skyrocketed at open, lunch, and closing. Why? Because thats when humans tend to trade. They go to home, they watch the evening news, they make up orders for the next day. Before going to lunch they move some stocks around figuring less people are watching, and before they go home they buy (or sell) based on lunchtime discussions and news. It’s all hunky dory until we realize it’s one big circle-jerk. Buying any volume of stock and then immediately selling it results in profit now because of all the bots hanging around trying to get a piece of the action. Suddenly, instead of buying things based on actual worth, they’re buying things based on perception when they perceive the stock might rise.

This is a recipe for disaster. Not only are we buying things which have no worth (and actually aren’t strictly property), but we’re not buying because they might have worth (a part of a company) but we’re buying because we see others doing the same thing. More on the point when no-ones watching what actually is going on, the opposite can be true also. A stock might have “bottomed out” but then when people start purchasing them, the robots get in on it. If the people then immediately sell, it’s very very likely a massive order could simply tank the automated process if one person is holding all the options. It’s generally non-optimal.

It’s also the plot of the latest Batman film! Go see it!