Wall Street's reliance on computers exposed
NEW YORK — For a few surreal minutes, a mere 12 words on Twitter caused the world's mightiest stock market to tremble.
No sooner did hackers send a false Associated Press tweet reporting explosions at the White House on Tuesday than investors started dumping stocks — eventually unloading $134 billion worth. Turns out, some investors are not only gullible — they're impossibly fast stock traders.
Except most of the investors weren't human. They were computers, selling on autopilot beyond the control of humans, like a scene from a sci-fi horror film.
“Before you could blink, it was over,” said Joe Saluzzi, co-founder of Themis Trading and an outspoken critic of high-speed computerized trading. “With people, you wouldn't have this type of reaction.”
For decades, computers have been sorting through data and news to help investment funds decide whether to buy or sell. But that's old school. Now “algorithmic” trading programs sift through data, news, even tweets and execute trades by themselves in fractions of a second, without slowpoke humans getting in the way. More than half of stock trading every day is done this way.
Markets quickly recovered from Tuesday's plunge. But the incident rattled traders and highlighted the danger of handing control to the machines. It raised questions about whether regulators should be doing more to monitor the relationship between social media and the markets.
Irene Aldridge, a consultant to hedge funds on algorithmic programs, said glitches and plunges may be inevitable with trading programs that just count the number of positive and negative words, without any filter.
“You can't ban Twitter,” said Aldridge, author of “High-Frequency Trading,” a guide to algorithmic trading.
Just how exactly the trading unfolded is still a mystery.
Some experts say the computers took their cue from humans, picking up on a pause in buying as traders read the phony tweet. In Wall Street's insanely fast trading world, humans holding back for even a second could have signaled to computers that buyers were drying up and that prices could fall, and so the computers should sell fast.
Others think computers may have sold on the tweet itself. That's possible because computer trading programs are increasingly written to read, and react to, news from social media outlets such as Twitter.
Experts say the fake tweet seemed designed to catch a computer's attention.
Rich Brown, head of Elektron Analytics, a Thomson-Reuters unit that sells news feeds that computers can read, said that the words “explosions” or “Obama” alone wouldn't have triggered selling. But add “White House,” and it's a combination even the slowest computer couldn't miss.
Brown said his service doesn't include Twitter in its feeds because there's too much useless “noise” in the deluge of tweets and, given the 140-character limit to tweets, often too little context.
Before the fake tweet appeared on Tuesday, it looked like any other good day on Wall Street. Unexpectedly strong earnings reports from Netflix and DuPont sent the Standard and Poor's 500 stock index up 1 percent at 1,578 with three hours to go in the trading day.
Then, at 1:08 p.m., a tweet appeared on the hacked AP Twitter account stating that two explosions at the White House had injured President Obama. Stocks immediately started falling and kept tumbling for two minutes. AP quickly announced that its account had been hijacked and the report was false. Prices began to climb again.
A group called the Syrian Electronic Army said it was responsible for the hack. The claim has not been corroborated. The FBI has opened an investigation into the incident, spokeswoman Jenny Shearer said.
The damage was big. The Dow lost 143 points, or 1 percent, in two minutes. In the frenzied selling, oil prices dropped, gold rose, the dollar rallied and the price of Treasurys, viewed by many investors as a hiding spot, shot higher.
Some Wall Street pros were surprised that a single tweet could move markets so much.
Julian Brigden, managing partner of Macro Intelligence 2 Partners, an investment consultancy, said the drop suggested an “unstable” trading environment dominated by investors too quick to buy or sell without any thought.
Although stocks eventually recovered for the day, investors have been on edge recently.
The S&P 500 and the Dow Jones industrial average lost 2 percent last week, their biggest weekly drops in five months. Investors were reacting to slowing Chinese economic growth, plunging commodity prices and mixed earnings reports from big U.S. companies.
The Boston Marathon bombing added to the jitters.
“People are looking for a reason to sell, and (Tuesday) it was a fake tweet,” said Adam Sussman, head of research at Tabb Group, a research firm.
But he thinks humans played only a minor role in the stock plunge. He said most professional investors are too savvy to sell on a tweet.
“They'd get a tweet from AP and then say, ‘Oh, was there a corroborating tweet from Bloomberg? A corroborating tweet from Thomson Reuters?' and so forth,” he said. “So I don't believe that anyone selling substantial money saw that tweet and just began selling off billions of dollars.”
Computer programs have come to dominate stock-market trading during the past 20 years. The goal is speed, and it's led to an arms race as companies develop ever-faster programs.
One of the latest weapons in the arms race is machine-readable news. The Thomson Reuters service scans 50,000 news sources and 4 million social media sites for stories.
Brown says his programs take news articles and announcements, and automatically flag answers to the essential questions — who, what, where, when and why. The answers are translated into a code that an investment firm's trading program can understand and then sent to clients. All of that takes less than one-thousandth of a second.
It's up to the investment fund to place a value on each word and rank established news outlets over other sources such as blogs or social media websites, Brown said.
Regulators have been studying the problems posed by automatic computer trading for years. Last month, the SEC proposed tighter oversight of automatic trading. Stock exchanges would be required to test their trading systems routinely, and report to the SEC about problems that could damage trading, like hacking.
“The exchanges love speed,” said Bart Chilton, a member of the Commodity Futures Trading Commission, a regulator that has been reviewing high-speed programs. “I'm not so sure that fast is always better.”