Program Trading Draws Fire - Again
PROGRAM trading - the Freddy Krueger of the 1987 stock market crash - is again seen as the nightmare on Wall Street. Critics blame it for last month's drop, when 190 points were slashed from the market on a single day. They charge that program trading triggers market-volatility, drives away smaller investors, is unfair, and worst of all, unethical, since it gives special advantages to the wealthy and well-connected. Program trading involves the use of computers to trade automatically in many stocks at the same time. It comprised one-fifth of all activity during the final hours of the market on Oct. 13.
The biggest component of program trading is stock index arbitrage - the trading of stock-index futures, designed to make money based on minute discrepancies between prices on the stock market and the futures market. During September, index arbitrage comprised 49.9 percent of program trading, according to the New York Stock Exchange (NYSE).
Program trading is ``a form of gambling,'' asserts Charles Wohlstetter, chairman of Contel, a phone company. Mr. Wohlstetter is organizing an alliance of NYSE-traded companies to fight program trading. One of his aides calls it a way for ``certain traders to make big commissions for themselves,'' irrespective of ``the good of the market.''
Wohlstetter is hardly alone in his criticism. Neuberger & Berman, a $17.5 billion investment management company, took out full-page newspaper advertisements a week ago urging curbs on program trading. Among other steps, the firm proposed that margin requirements on index futures be set at 50 percent, the same as for equities. Currently margins on index futures run around 5 percent.
Last week, a number of powerful investment houses, including Shearson Lehman Hutton, Merrill Lynch, Morgan Stanley, Kidder Peabody, and Bear Stearns, said that they will stop engaging in program trading for their own accounts, although most will continue to use it for their customers. Little wonder that the NYSE, Congress, and the commodity exchanges are considering tighter rules for program trading.
``Program trading is the equivalent of financial pollution,'' argues Avner Arbel, a professor of finance at Cornell University. ``It benefits the polluters [meaning short-term traders] but it's bad for the financial environment.'' Dr. Arbel is not convinced that program trading actually increases market volatility. In that sense he agrees with William Schreyer and Daniel Tully, chairman and president, respectively, of Merrill Lynch. They argue that ``the causes of excess market volatility are far more complex.''
But to Arbel, program trading diverts attention from the main reason for the stock market - ``long-term investing for growth and dividends, based on the fundamental characteristics of a company ... Stocks are traded as if they were commodities.''
``It is also an unequal game,'' Arbel maintains. ``It is not offered to everyone, so it is wrong. To play that game, you need to have direct access to market information on a second-by-second basis. You have to have direct access to the trading floor [of exchanges]. You need to act immediately on buying and selling. Finally, you have to have a lot of money, because the gains are so small in program trading.'' About five major financial firms and their clients are the main players in the program trading market.
Will program trading this time be halted once and for all, unlike in 1987, when curbs were imposed, only to be lifted later?
Many market experts believe program trading will continue, although with some possible restrictions, such as higher margin requirements. Ultimately, only Congress can curb program trading outright, which seems unlikely. ``The perception of program trading is worse than it actually is,'' maintains Thomas O'Hara, chairman of the National Association of Investors Corporation, a group representing small investors. ``If you are truly a long-term individual investor, then program trading should not affect you at all,'' he says. Short-term traders, those who enter and leave the market on a daily or weekly basis, could be hurt, he says. ``But unfortunately, that's their game,'' Mr. O'Hara says.