EDMOND — Texas singer-songwriter Townes van Zandt once told Emmy Lou Harris that there were only two types of music: the blues and zippity do da. Many people had a serious case of the blues on May 6. About the only whistling that was going on was like whistling past the graveyard.

Thursday, May 6, 2010, will go down in history as one for the stock market record books. Unless you have been living off the planet somewhere, you undoubtedly know that the Dow dropped almost 1,000 points during that day and finished down about 350 points. It was a wild ride.

You also could call it “the day the machines took over.” I have never been a fan of the computerized program trading that has become so common among big institutional traders. Of course, nowadays they call it “high frequency trading,” as if that somehow makes it better. 

Whatever you call it, it serves no purpose other than lining the pockets of the program trading firms at the expense of all the millions of other investors participating in the market. It’s just one more way firms like this are turning the markets into giant casinos, while the average investor gets mowed over in the process.

The first time we saw something like this was during the October 1987 crash.  Later investigations revealed that what would have been a normal down day in a correction that had begun in August was turned into a heart-stopping, portfolio destroying crash by the uncontrolled automated waves of sell programs that flooded in from the program trading firms. They overwhelmed the market.

In addition to their normal high frequency, short-term trading to take advantage of each piece of news that hits the tape before normal traders and investors can react, the computers had been programmed to provide “portfolio insurance” for themselves. That is, if the market dropped below certain protective stops, the computers were programmed to execute large sell orders to get out of the market. If that resulted in an even lower protective stop being hit, the computers automatically sent another wave of sell orders at the lower prices.

The result on Oct. 19, 1987, was that the automated sell orders were coming so fast on top of each other that market-makers could not match them up with buyers. It didn’t take long before there were no buyers anyway, and the decline just plunged into a dark bottomless hole and the exchanges had to be closed.

By the way, as a point of reference, the May 6 crash was not even close to the worst crash ever. Although the Dow was down 1000 points at its low on May 6, that was about a 10 percent drop. In October 1987, the Dow was then at 2,246 the day before, so the 502 point decline was a whopping 22.6 percent drop in one day. Ouch!

After 1987, curbs were placed on program trading to try to rein it in. The curbs called for the market to be closed for cooling-off periods if the Dow fell a certain number of points in a day. But, as a result of lobbying by Wall Street during the years, those curbs have been watered down and mostly eliminated, along with the uptick rule for short selling, in the 1990s. At the same time, the computers and the models have become faster and even more sophisticated.  The average investor doesn’t have a chance.

The program trading firms claim their activity is needed because it provides liquidity to the market. Well, the markets were a lot more stable, liquid and understandable before computerized high frequency trading became such a force. The laughable idea that it provides liquidity was surely proven wrong on May 6.

Whether caused by human error or investor panic over events in Europe and overbought conditions, stocks were falling sharply. With the Dow down 450 points, the protective stops programmed into the automated program traders’ computers began to be hit. There was no liquidity provided by program trading firms because no one was taking the other side of sell orders. The Dow plunged to being down 1000 points in 20 minutes before someone realized what was going on and pulled the plug.

Some have likened it to yelling “fire” in the theater and everyone runs to the door. But in the theater analogy, you don’t have to find someone to take your seat as you run out. In a stock market panic, you have to sell to someone at a time when no one wants to buy. Innocent investors lost billions by being artificially panicked into selling — trades they probably would not have made otherwise.

So who are the program-trading firms? The top 10 program trading firms that week were Morgan Stanley, Goldman Sachs, Barclay’s Capital, Wedbush Morgan, Credit Suisse, Deutsche Bank, JP Morgan, RBC Capital (Royal Bank of Canada), Schon-Ex and Penson Financial. 

This activity needs to be banned. You can add this to the list of things our congressional representatives should be adding to financial regulatory reform.  But don’t hold your breath. Until then, I’ll be here whistling zippity do da. Thanks for reading.



NICK MASSEY is a financial adviser and owner of Householder Group Financial Advisors in Edmond. Massey can be reached at www.nickmassey.com. Securities offered through Securities Service Network Inc., member FINRA/SIPC.