What was the Wall Street wipe-out all about?

For a few minutes last night, shares on Wall street went into free fall, with the Dow Jones down over 9% at one point. So what on earth was going on?

Did you see what happened on Wall Street last night? For a few minutes, it was very scary stuff.

While we were fretting about the election, US shares went into freefall. At one point, the Dow Jones Industrial Average dropped by more than 9% in a 1,000-point plunge. Even some big blue chips sank by over 50%.

Subscribe to MoneyWeek

Become a smarter, better informed investor with MoneyWeek.

And although the index then bounced back, it still closed over 3% lower.

So what on earth was going on?

Advertisement - Article continues below

Stocks were heading down anyway. US investors have begun fretting about how widely Greece's woes could spread. Commodities guru Jim Rogers said stocks were "overdue for a sell-off". And Marc Faber of the Gloom, Boom and Doom report said it was time to trim holdings as "the market was overbought, ahead of itself and due for a correction".

But then the gremlins got in, in droves. "Computerised trades sent to electronic networks turned an orderly stock market decline into a rout, according to Larry Leibowitz, CEO of NYSE Euronext", says Bloomberg.

And that's where it gets technical. Stock market trading has moved on a long way from the days of chaps wearing top hats.

Nowadays, some 60% of US share volume is carried out via computer-driven, high-frequency trading. This uses complicated computer algorithms, based on a range of outcomes, to trade automatically at speeds of millionths of a second.

And while the likes of pension funds are doing the deals, in many cases there's no one pressing the button. The machines do it all because they can act much faster than people.

Like everything else to do with technology, it's great when it works. But when the machines take over, as we saw yesterday, all hell breaks loose.

Advertisement - Article continues below

No one yet knows how it started, if it was caused by a huge error, if it was done deliberately - or if it will happen again. But the financial fuzz are now getting stuck in. Both the US Securities and Exchange Commission (SEC) and the Commodity Futures Trading Commission say they'll be looking at "unusual trading" patterns. And at least the exchanges are cancelling some of the most suspicious trades.

America's politicians want their say too. "This is unacceptable", says Democrat Paul Kanjorski. "We can't allow a technological error to spook the markets and cause panic".

"The potential for giant high-speed computers to generate false trades and create market chaos reared its head again", says Senator Edward Kaufman. "The battle of the algorithms - not understood by nor even remotely transparent to the SEC - simply must be carefully reviewed and placed within a meaningful regulatory framework soon".

Of course, we've been told all this before. The 1987 crash was widely put down to "programme trading" - the 1980s equivalent of the today's high-speed algorithms - getting out of control. And the clever clogs were supposed to have stopped it happening again.

But they clearly haven't. And I've no faith that they will in future. That's because, despite what the regulators say or do, the traders are always at least one step ahead of them.

And regardless of what we're told by the experts about a computer programme being infallible, it almost certainly isn't. That applies to analysis models as well as to black-box trading schemes.

Advertisement - Article continues below

So what's the bottom line?

There's nothing that you, the individual investor, can do about dodgy computerised trades. But you can protect yourself from the fact that the underlying fundamentals don't look good. We agree with Rogers and Faber that stock markets generally look both over-expensive and 'toppy'. And we've been expecting an overall pullback, particularly in the US.

So if you're in the market, we'd stick with the big, defensive blue chips. And if you haven't already taken profits on your cyclical stocks, it's probably worth doing so.




The British equity market is shrinking

British startups are abandoning public stockmarkets and turning to deep-pocketed Silicon Valley venture capitalists for their investment needs.
8 Nov 2019

Why Wall Street has got the US economy wrong again

The hiring slowdown does not signal recession for the US economy. Growth is just moving down a gear, says Brian Pellegrini.
25 Oct 2019

There are lots of reasons to be bearish – but you should stick with the bulls

There are plenty of reasons to be gloomy about the stockmarkets. But the trend remains up, says Dominic Frisby. And you don’t want to bet against the …
17 Jul 2019

Good news on jobs scares US stockmarkets

June brought the best monthly US jobs growth of the year, but stockmarkets were not best pleased.
11 Jul 2019

Most Popular


Three things matter for the UK housing market now – and “location” isn’t one of them

The UK housing market is frozen. And when it does eventually thaw out, the traditional factors that drive prices will no longer apply. The day of reck…
1 Apr 2020

What does the coronavirus crisis mean for UK house prices?

With the whole country in lockdown, the UK property market is closed for business. John Stepek looks at what that means for UK house prices, housebuil…
27 Mar 2020

Has the stockmarket hit rock bottom yet?

The world's stockmarkets continue on their wild and disorientating rollercoaster ride. Investors are still gripped by fear. So, asks John Stepek, have…
2 Apr 2020

Oil shoots higher – have we seen the bottom for the big oil companies?

Just a few days ago everyone was worried about negative oil prices. Now, the market has turned upwards. John Stepek explains what’s behind the rise an…
3 Apr 2020