Don’t trade on news—especially unverified news

A flash crash shortly after 1 p.m. today should never have happened. Usually when the market dips and quickly recovers it’s because of a data entry error—an extra zero in a sell order. But this one was the product of sheer stupidity—and maybe deliberate malice.

A hacker cracked the Associated Press Twitter feed and sent a fake news item claiming explosions at the White House had injured the president. Almost instantly, the markets dropped 1 percent, which doesn’t sound like a lot. And in the big picture, it’s not. But 1 percent was the entirety of the day’s gains up to that point.

DJI = Dow Jones • INX = S&P 500 • IXIC = Nasdaq

You see the markets recovered almost as quickly. The problem, apart from the fact that the AP’s account shouldn’t have been hacked in the first place, is that the drop seems to have happened without human intervention.

In this CNBC article about the matter, Kenny Polcari of O’Neill Securities is quoted as saying, “That goes to show you how algorithms read headlines and create these automatic orders – you don’t even have time to react as a human being.” What he’s implying is that computers are programmed to sell based on news headlines, without first verifying those headlines elsewhere.

In one of the great old Tom Baker episodes of Doctor Who, an episode about a doomsday machine, the Doctor said, “The trouble with computers, of course, is that they’re very sophisticated idiots. They do exactly what you tell them at amazing speed. Even if you order them to kill you.”

Today’s flash crash is an excellent example of why safeguards need to be in place to prevent computers from doing stupid things at amazing speed. The event is just a blip on the market’s long-term radar, but anyone with an automated sell order that got mistakenly triggered by this fiasco is probably rethinking their algorithms about now.

More important still is the fact that news—even verified real news—is rarely a good reason to sell off stocks. That computers can be tricked into killing off the stock market, even momentarily, by a lie highlights the need for human supervision, but it also shows the importance of trading on fundamentals, not on rumor and innuendo.