Are you a news junkie? If you are, hopefully you’re not making investment decisions based solely on the financial news or stock market analysis that the media provides all day and every day. When the stock market goes down, they say ask the question, “Has the next recession finally arrived” and when the market goes up they ask, “Are we at the beginning of a new bull market?”
What they don’t often tell investors is that the reality of why a market moves is actually far more technical than that. Often the market moves based on factors found in stock charts and algorithms being used by a certain type of trader and this trader is responsible for 75% of all trades in the stock market each day. If you don’t know about
this trader, the chances are high that you’ll lose money.
Two Types of Analysis: In the world of stock market investing, there are two ways to analyze a stock. Fundamental analysis looks at the company itself. How much cash do they have, is their product in high demand, is their competition better at what they do than this company? What is their price to earnings ratio?
Fundamentalists also look at the overall market. How’s the economy? Are people buying anything right now? Are gas prices so high that people don’t have extra money? Is there a war going on in a country that supplies our oil?
The other type of analysis is technical analysis. Pure technicians don’t care about much of what the fundamentalists study. The technicians look at the stock’s chart. They look for patterns in the numbers and they invest based on those patterns.
There are very few pure technicians. Most technicians take in to account many of the fundamentals, but their overarching opinion comes from those stock charts.
75% of all trading is no longer done by humans. High frequency trading takes on many definitions, but in this case it is when computers are buying and selling millions of shares literally in seconds and sometimes fractions of a second. Where do you find those purely technical analysts? In the computers. The computers can only look at patterns of numbers and take actions based on the math. As of now, a computer cannot be programed to consider the price of a product and whether or not it will be too expensive in an economy that is close to a recession.
Not everybody believes that high frequency trading is responsible for big stock market moves in the market, but on the surface it looks relatively clear-cut. If one person were making three quarters of the stock transactions, the market would most likely move based on the trading activity of that person.
The media’s analysis of why the market went up or down on a given day may be right, but other than the high frequency trading computers (as well as other technicians reacting to the fundamentalists), what really moved the market was largely the result of some complex math ran by a series of computers.