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Wall Street Relying On Machine Learning Algorithms And How It Connects To The GameStop Stock Price

Popular media portray the infamous ’Wall Street’, as a cacophony of human voices shouting bets, telephones buzzing, and frantic flurry of investors buying and selling stocks. However, the financial world is very different today, with 85% of trading orchestrated automatically via machine algorithms. These new technologies have changed the face of Wall Street beyond recognition. The orchestra of human shouting is replaced by the quiet humming of computers, buying and selling at speeds that investors cannot comprehend. Trades can be executed in less than half a millionth of a second, which is over a million times faster than the human mind can make a decision. However, the recent GameStop stock mega jump caused by… Reddit highlights an area where machine learning algorithms will not be able to predict much. 

Transition From Eight Years Stocks To Five Days Stocks

The machine learning algorithms trade for fractions of a cent, buying and selling thousands of stocks per second, competing against similar design algorithms, exploiting second by second mild volatilities in stocks. For example, an algorithm buys a stock at $2.00, and milliseconds later it sells at $2.00001, creating a mild profit. Executing similar transactions thousands of times a second, the profits add up. A testament to the dynamic changes in the financial field, in the 1950s stocks was held on average for eight years, now they are held on average for five days.

Algorithms are complex mathematical equations, utilizing machine learning and AI to make decisions based on probabilities. These lines of code don’t read market forces like us humans do, they don’t operate based on stories, they operate on cold data, ones, and zeros.

Dow Jones’ Lexicon Creating Trading Strategies

Dow Jones released a new service called Lexicon, which analyses the news and converts it into measurable, trading strategies which the algorithm can read, and come to individual conclusions. Market forces react to the news, current events in the world, political decisions, or natural disasters have a drastic influence on stock market prices.

Rob Passarella, vice president of institutional markets at Dow Jones, said Lexicon “represents the next frontier in analytics by providing traders, quants, and researchers with new ways to uncover trends and opportunities. We all know that news moves financial markets, but the challenge has always been to quantify the news in multi-factor models and analysis”. The algorithms can outcompete the sharpest business-minded investors, by picking up on slight nuances and distortions in the market prices, to gain profit.

Machines can monitor trends, analyze past behavior, and use probabilities to buy and sell.  The financial market is fickle, the volatility cannot be anticipated, therefore slight nuances and historical trends are best analyzed with machine algorithms. Furthermore, with the constant monitoring 24 hours a day without succumbing to fatigue, continually refining algorithms, and instantaneous selling and buying, machines can outcompete the best of humans. However, with a collective unprecedented trading herd, the forces sometimes move very quickly in unison, much faster than previous traditional financial markets would.

“Meme Stocks”, GameStop, And Why Machine Learning Algorithms Cannot Predict Them

An area which machine learning algorithms are unable to predict, are the ‘meme stocks’. Shedding light on the recent events that transpired with the Gamestop short squeeze. Gamestop is an American video game retailer, which has been speculated to become obsolete soon, due to the digitalization of media and the recent bankruptcy of similar outlets. However, the stock skyrocketed from $20 USD to over $400 USD. Usually, sharp increases are the result of new emerging technologies or promising sales reports, but there were no remarkable developments in Gamestop, except coordinated Reddit discussions. Utilizing commission-free fintech app Robinhood to buy the stock, lots of amateur investors from Reddit social media websites were able to collectively buy and drive up the stock price. 

Reddit Alone Determining Stock Prices And Confusing The Machine Learning Algorithm

This stirred a new term, called “Meme Stock”, in which the coordinated discussion of Reddit groups to invest in a stock, without any other influences, makes it extremely unpredictable for machine learning algorithms. The algorithm cannot predict this drastic increase in value based on the current machine learning algorithms in place, and the initial increase in price was determined as an anomaly by most algorithms. Needless to say, the Reddit short squeeze on wall street was successful.

The reason why the prices skyrocketed, is because the Reddit traders targeted the short-selling hedge funds, which are traders betting on the stock to drop, causing a short squeeze. A short squeeze is an event in which stock prices increase, forcing traders who initially bet for the price to fall, to buy the asset to combat further losses, thus creating further upward pressure on the stock price. The Reddit platform urged others on the discussion board to buy stock, and help boost its price, a joint anonymous collaboration to alter market forces.

If you are interested in the stock market, machine learning, and trading algorithms, you may also like:


Was The Reddit Stock Price Rally Fraudulent?

There is controversy whether the act by Reddit was considered fraudulent, coordinated efforts to manipulate stock prices. Market distortions are a felony, but proving manipulation is very difficult in these circumstances, according to John Coffee, a law professor at Columbia Law School. Coffee said it is a “mob of uninformed, unsophisticated retail traders. There is no theory of liability under the federal securities laws that is harder to prove than manipulation. You are looking for the evil needle in the huge haystack of uninformed, deluded fools. As for ‘squeezing the shorts’, that too is possible, but it is easier to make money by just riding the roller coaster up and seeking to sell at the top”.

There has been a history of market manipulation orchestrated by banks, causing jail sentences. Navinder Sarao for example was arrested for fraud and market manipulation in 2015, for igniting a panic, causing a flash crash in which markets briefly lost $1 trillion. However these are individuals, the Reddit boards are collections of anonymous users, making it difficult to pinpoint blame. Although, the Securities and Exchange Commission said they don’t think alleged Reddit members will be charged with any wrongdoing.

In a world where the edge is given to the faster machine, the more sophisticated algorithm, a vicious cycle pushing the technology to become smarter and faster. The recent events showed that human amateur investors outwitted the machine, and underdog story beating the corporations backing the algorithms. Although the algorithms may adapt to combat future short squeezes, it was a win for Reddit. As algorithm intelligence is only going to increase, there is a trend to driving out human involvement entirely. Soon humans will become obsolete, bystanders as machines push around the money which humans created. 

Jon is a writer for RegTech Global, specialized background is in Computer Science, Zoology, Finance, and Neuroscience. He is interested in biotechnology and Green-tech and pursues these fields in his professional life. Outside of writing, Jon is passionate about the outdoors, enjoying hiking, surfing, and skiing.


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