Program trading refers to the transaction of large amounts of several stocks, usually done by computers. It can encompass a wide variety of portfolio strategies. The New York Stock Exchange has defined program trading specifically as a trading strategy where at least 15 stocks with a market price of at least $1 million U.S. Dollars (USD) are traded. The word "program" in program trading does not necessarily refer to a computer program, but rather to a predetermined set of steps which comprise a trading strategy. Program trading can be thought of, in simple terms, as trading an entire portfolio at once, instead of one stock at a time.
In some cases, program trades are subject to certain regulations in order to ensure that they will not contribute to market volatility. These types of trades are not especially well-known, but they are the subject of controversy nonetheless. This is because of the perception that program trading is often the culprit for large, sudden movements in stock prices, especially downward movements. There are many who see program trading as the main culprit for the stock market crash of 1987, specifically for the large increase in prices that preceded it.
The increased use of computers on Wall Street as a part of stock trading has helped make program trading as popular as it has become, and has created even more ways to make money. One of the ways in which this has occurred is that large funds find it more profitable to engage in trades that are broken up in pieces, rather than doing one large trade all at once. This may seem like a departure from the program trading style, but in reality it is simply a variation of it, which lessens its impact on the market.
Hedge funds and mutual funds often engage in this modified type of program trading. If, for example, a family of mutual funds wishes to take on large positions in a certain group of stocks, this fits the definition of a program trade. However, to place a large trade in many stocks all at once would cause the market prices to swing wildly upward in order to accommodate the sudden increase in demand.
This would not only defeat the purpose of placing such trades, but it would likely confuse market participants as well. Using computer programs to govern these transactions, large funds instead increase their positions over the course of days or weeks, avoiding a large impact on the markets for the stocks they buy. This still drives the price of these stocks up, but not as much or as quickly as would otherwise happen.
