BOT Crazy: The Power of Automated Trading Algorithms
The dramatic surge in Lyft's share price following a gargantuan typo in their earnings release earlier this week serves as a case study on the potent influence of algorithmic trading bots in the financial markets. The markets quick, and at times, merciful yet unforgiving response to real-time data can significantly influence share price, and change fortunes. In the case of Lyft, its price popped—in the right direction—after the news went viral. And continues to maintain upwards momentum, highlighting the importance of accuracy in financial communication.
Over 70% of all trades are now executed by algorithmic trading bots. Algorithmic trading, also known as algo-trading, black box trading or automated trading is designed to execute trades at speeds and volumes unattainable by human traders, and dominate the markets—especially during after-hours trading. These algorithms scan the news, financial reports, and other data sources for indicators that guide their trading decisions. It works based on price, timing, quantity, or any other supporting mathematical models. This type of trading has become popular due to its ability to generate fast profits at a level that is impossible for a human.
The typo in Lyft’s earnings release was massive: the company initially reported adjusted EBITDA margin expansion of approximately 500 basis points or 5%, of growth yearover-year instead of 50 basis points, or 0.5%. The forecasting error came to light on the conference call after the news release was issued.
The significant increase of such an important profit metric triggered a buying frenzy among the bots, who capitalized on the opportunity raking in profit without human BOT Crazy: The Power of Automated Trading Algorithms interference. Lyft opened on February 13 at $11.97, and closed at $12.14. After the bell, shares jumped 62% to reach a closing high of $16.77 on February 14 with volume up an astounding 581%!
That’s the mighty sword of algo-trading in action, slicing through the market with decisiveness but, it also demonstrates how errors can lead to dramatic swings in stock prices based on rapid reactions to data, whether accurate or not.
It also proves out market efficiency and liquidity. On the other hand, it can exacerbate market volatility and lead to situations where stock prices are driven by gaffes and glitches more than fundamentals. Bear in mind, Lyft’s error was not disclosed until after the call at 4:30pm ET, with a corrected news release issued at 6:02pm ET. While the company still beat earnings estimates, there was little movement on the stock until after-hours trading kicked in.
It also goes to show that a single digit can alter the financial landscape within minutes. For investor relations, the incident serves as a cautionary tale about the potential positive or negative consequences of misinformation, whether intentional or accidental. Effective communication is not merely about broadcasting information but ensuring rigorous accuracy. This includes a responsibility to promptly address and correct misinformation to protect the company's reputation and investor trust. Moreover, developing strategies that consider the impact of these algorithms on stock price movements is becoming increasingly important.
