DID YOU KNOW
The News Effects Trading Algorithms
In our Do or Did You Know? blogs we provide readers with useful information that generally is not realized by inexperienced investors. In Chapter 1 and 6 of our publication, When to Buy and When to Sell: Combining Easy Indicators, Charts, and Financial Astrology (available on Amazon), we briefly discuss human emotion, sentiment, news, and algorithms.
The advent of trading algorithms in the financial arena has had a profound effect on institutional trading. More specifically, news headlines and events have a measurable impact on these algorithms, influencing both short-term price movements and long-term market structure.
Algorithms, also known as trading bots, are programmed to automatically enter and exit positions based on nominal price moves, percentage moves, stop losses, chart patterns, volume indicators, support & resistance, and many additional strategies. These “bots” also remove all emotion, as they are pre-programmed, and allow the avoidance of any straying from one’s trading objective/plan.
Speed is the major impact that these High-frequency trading (HFT) systems have on trading platforms, as they can react to these triggers, including the news, in milliseconds, far faster than even the most experienced human. Since institutions are often dealing with tens of thousands of shares at once, they sometimes are only seeking a 1-2 cent move in the price of an equity, much less than the average trader. Therefore, the buy and sell orders are much tighter and need to be filled immediately. These systems provide an obvious advantage over the manual procedure of placing an order, though the speed of these transactions can amplify volatility. We often suggest in our publications that the retail trader should keep their stop-losses mental, and out of the system, as the market makers can see, and manipulate them. This is of no concern to the institutions, as they themselves move the market, and the sheer volume of shares they trade cannot be manipulated.
And, yes, these systems can be used to analyze the news to also enhance trading. Research confirms that modern algorithms are capable use real-time news analyzation, AI-powered sentiment analysis, and keyword detection (from press releases and earnings reports) to identify market-moving events. These systems are also capable of distinguishing between numerical data and qualitative statements, triggering trades within seconds. For example, during the 2023 Silicon Valley Bank collapse, algorithms exploited rapid shifts in liquidity, capturing large gains in Puts (bearish options trades), Treasury futures (bonds), and Cryptocurrency assets.
Specifically, like most Artificial Intelligence (AI), machines can process information (known as reinforcement learning), much faster than a human, to combine price data with contextual news items. They have the capability to capture the actual meanings in news text, allowing algorithms to adapt to changing market environments and make more accurate short-term decisions.
News-driven trading can also cause liquidity adjustments/reductions, which create volatility spikes in the short-term. This is especially true for press releases, which are timelier and easier to interpret algorithmically. Although the analytics may not always be perfectly accurate, small price distortions can be quickly corrected.
Strategic improvements are always being made, of course, to remain a step ahead. Currently, leading firms are moving beyond raw speed to insight-driven execution, using news context to determine the most beneficial trade opportunities. This includes anticipating news (pre-release positioning), and adjusting liquidity strategies during heightened volatility. The old adage of “Buy the rumor, Sell the news” has never been more prevalent since the onset of AI trading. Do you ever wonder why you can’t ever seem to get ahead of announcements? Besides the ongoing suspicion that “insiders” receive the news first, these programmed algorithms create immediate responses, which effects price action well before the general public hears the news themselves.
To summarize, the “news effect” is now a core component of algorithmic trading, shaping both execution strategies and market dynamics. Short-term price action triggers, increasing learning performance built into mechanical systems, liquidity crunches brought on by news exploitation, and the speed of which it all happens causes another disadvantage for the retail trader. Short-term swing traders are at the largest disadvantage, as trend changes occur at a significantly faster pace than in the past, and many times there is no anticipation of any news or the upgrade/downgrade of a stock. Unless one is very seasoned, and uses complex spread option trades, it is wise to steer clear of trading earnings announcements, or holding a large number of shares in a company that is not a long-term investment.
*** As always, this information is not intended to be financial advice, and should not be considered as any specific buy or sell recommendation, but rather a guide to assist the reader in some further understanding of the financial markets.
