Computerised stock trading: History isn’t a guide when market is playing by a new set of rules

Whenever something drastic happens on the stock market, traders immediately delve into the history books.

Why? Because they believe the past holds the key to predicting the future.

History will tell them that stocks recovered – albeit slowly – from Black Monday in 1987, the dotcom boom and bust at the turn of the millennium, and the 2008 collapse of Lehman Brothers, so you could forgive them for remaining upbeat.

But the market has become an increasingly complex and difficult beast to predict, with wild swings in share prices in the past few months.

Take, for example, Glencore. All it took was a note from an investment bank on Monday to wipe 30 per cent off the value of the commodities giant in a day.

In the past, a fall of that magnitude might have been caused by a company declaring bankruptcy – although admittedly, that’s what Investec, the broker in question, suggested could happen if metals prices remain depressed.

It’s not unusual to see lower volumes in the summer months as many City folk take time off for a well-earned holiday, hence the old stock market adage “Sell in May and go away, don’t come back ’til St Leger Day” – the last classic flat race in the horse racing calendar.

But since Simple Verse won this year’s St Leger on 12 September, the stock market’s wild ride has continued, with illiquid trading suddenly replaced by huge stock movements – especially down.

Uncertainty about the global economy – the Chinese economic slowdown, when the US will raise interest rates, depressed commodity prices – is mostly to blame.

Darren Hepworth, the director of global trading and customer services at TD Direct Investing, says that since August – when the big sell-off triggered by the Chinese share slump hit global markets – investors have been sitting on their hands waiting to see how things pan out.

And when a stock moves one way, the herd follows, triggering the sort of mass sell-off seen with Glencore.

Hepworth said: “If you’re an investor right now you’re looking for strong signals to determine when the time is right to come back into the market. If you’re a [retail] investor and you see the market’s up or down 5 per cent – this one’s been suspended, that’s had a profit warning – you’re going to take a lot more time deciding where to put your investment.”

Chris Beauchamp, senior market analyst at IG Index, agrees. “We’re waiting for a big reason to come in, whether that’s the European Central Bank extending QE [quantitative easing] or the Chinese doing something,” he said.

“At the moment we haven’t got that evidence. That’s why all those bounces you get only last a couple of days then melt away again.”

That may be true, but an unstable global economy is nothing new.

David Buik, a City of London veteran and a commentator for the stockbroker Panmure Gordon, has a theory – and it’s one echoed by many who have seen trading evolve over the years.

“I think we forget that 40 per cent of trades are programme trades,” Buik explains. “The number of what I call ‘numeric geeks’ that now work in the markets would never have considered being in the markets 50 years ago.

“You’ve got a totally different person. He’s incredibly bright and he works out programmes that decide when it’s time to buy and sell. When you’ve got that kind of influence [on the market] you get that level of volatility.”

Automated trading has changed the way the stock market works beyond all recognition.

Instead of holding a stock for years, months or days, as was the norm in years gone by, shares can now be owned for a matter of milliseconds.

For example, a programme could be created to buy a stock when it reaches £10 and sell it at £10.0001. It might not sound like a big gain, but do it many thousands of times and it can make a tidy profit.

High-frequency trading of this nature is also to blame for the “flash crashes” that have happened in recent years.

So-called “stop-losses” can be put on trades, meaning that when a share price falls below a level determined by the investor, it is automatically sold, limiting their loss.

For investors, it can mean the difference between a small loss and a catastrophic one – as plenty of those Glencore backers would attest to.

But inevitably, automatic stop-loss sales drag share prices down and trigger more selling, causing a dangerous domino effect as investors are automatically bailed out.

The stock market is being played or manipulated by financial whiz kids – all completely legally, of course – but it is not what the market was intended for – investing in a company for the benefit of the backer and the recipient.

The result is that the market has become increasingly detached from the real world and not a fair reflection of what most see as an improving outlook for the global economy.

America, the world’s largest economy, is on the up and an interest rate rise is still expected this year. Yet the US stock market does not reflect that, with its benchmark Dow Jones average falling 8 per cent in the third quarter.

Buik says: “I don’t recall volatility of this nature. I don’t recall daily turnover [in terms of trades] of this level when we’re not in a crisis. The world is not about to fall off the axis and we’re not even close to being in a global recession.”

Analysts expect the market to continue to blow hot and cold until we have clearer signs about the global economy.

Nigel Green, the chief executive of the financial consultancy deVere Group, believes October is likely to be characterised by more volatility. “As such, investors must act now to ensure that they have a truly well-diversified portfolio,” he advises.

In other words, don’t put all your eggs in one basket in the current climate or you could come a cropper.