Critics Blame Market Nose Dive on Program Trading, Call for Reforms

Program trading could increase stock selling on Monday and revive the debate over whether the computerized trading technique should be more closely regulated.

Analysts blamed much of the stock market’s nose dive Friday on the controversial technique, and critics worried that a weekend buildup of computer-generated sell orders could spark a far sharper plunge on Monday morning.

“Now we are faced with a gut-grinding weekend,� said Philip B. Erlanger, chief technical analyst for Advest, an investment firm in Hartford, Conn. “The Friday before the Oct. 19 crash was not as bad as this Friday.�

The Dow Jones industrial average dropped 108 points the Friday before Black Monday. This Friday, the Dow plummeted 140.58 points.

Program trading was restricted immediately after the Oct. 19 crash, but the system is now back in place and Erlanger and others expressed concern that the stage could be set for another major fall on Monday.

“This industry will never learn from its mistakes,� said Michael Metz, a market strategist for Oppenheimer & Co., an investment house in New York. He blamed program trading for 90 to 100 points of Friday’s 140.58-point drop.

Most of the drop occurred during the final frenzied hour of trading. Prices had weakened throughout the morning and held at lower levels until mid-afternoon. Then market players moved to lighten their holdings and take some profits in advance of the weekend.

The additional selling pushed stock prices lower, apparently reaching levels that triggered the computers to spew out their sell orders. That, in turn, pushed prices down further.

Unnerved investors worried that the market was signaling a repeat of the mid-October crash and they unloaded more stock. The effect of the selling was exaggerated because a snowstorm in New York had sent many traders home early.

One trader called Friday’s events “a mini-meltdown,� a reference to a statement by the head of the New York Stock Exchange, John J. Phelan, that the 508-point drop on Oct. 19 had been a meltdown.

Computerized program trading systems are designed to generate sell orders when the stock market declines by a predetermined amount. The computers direct multimillion-dollar blocks of stock and a flood of sell orders can create enormous downward pressure on the stock market, stimulating still further computer sell orders and also panicking individual investors.

Restrictions Removed

The effect can be heightened by the most common program trading technique, arbitrage trading. It involves professional traders using computers to speculate back and forth between stocks and stock indexes on the futures market to take advantage of minor price discrepancies.

Nearly 10% of the shares sold on the New York Stock Exchange on Oct. 19 were sold under orders from computers doing arbitrage trading, according to government reports.

After the crash, the NYSE told its members to temporarily stop using one aspect of program trading, which effectively halted the practice. When the market calmed down, however, the restriction was removed and program trading resumed.

Several studies have attempted to assess the role of computerized program trading in the October market collapse, the worst in U.S. history. They reached differing conclusions.

Reports by the NYSE and the Chicago Mercantile Exchange said the technique did not drive stock prices down. But the NYSE report said it does sap public confidence in the markets.

A special report released Friday by a commission appointed by President Reagan concluded that program trading had a role in the Oct. 19 crash.

But Erlanger, the Hartford analyst, complained that federal officials have refused to restore stability to the stock market by taking what he views as an essential step--eliminating all trading on stock index futures, which would cripple most program trading.

Market Psychology

“The people in Washington have lost sight of the original purposes of the stock market, which were to raise capital for corporate America and provide an opportunity for individuals to invest in corporate America,� he said.

Erlanger and other critics complain that investing on stock index futures--which resembles traditional commodity futures trading--is simply speculative gambling that contributes nothing to the economy and, when coupled with computerized trading, can destabilize the stock market.

William J. Brodsky, president of the Chicago Mercantile Exchange, where the futures markets are concentrated, declined to comment on any role that futures trading might have played in Friday’s market drop.

What happens Monday will depend both on program trading activity and the psychology of the marketplace, which are tightly intertwined.

“Oct. 19 is still fresh in everyone’s mind,� Thomas Gallagher, a managing director at Oppenheimer & Co., told the Dow Jones News Service.

Erlanger was more blunt: “This is not a sane market. This has nothing to do with the fundamentals of the stocks. This is a psychological phenomenon.�

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Source: Associated Press