Program Trading Blamed for January Stock Contortions

January’s sharp stock price gyrations were largely the result of controversial program trading strategies, according to figures released Tuesday by Birinyi Associates, a noted New York consulting firm.

The Dow Jones industrial index, a key indicator of market activity, soared that month to an all-time high of 2,810.15 before plunging nearly 300 points during several jittery days. More notable, though, were the wild swings in market prices that characterized the month’s trading, market experts said.

“I have been watching the market for 40 years now, and I have never seen it this erratic,” said Richard Russell, publisher of Dow Theory Letters in La Jolla. “I think to a large extent it reflects program trading.”

Figures released by the New York Stock Exchange and Birinyi Associates seem to underscore the point.

During the first two weeks of the month, program trades could account for well over half the net gains and losses in the Dow Jones industrials, according to an analysis released Tuesday by Birinyi Associates. (There is about a month’s delay in getting program trading statistics from the New York Stock Exchange.)

Also, the exchange reported that program trading spiked upward during the month to nearly 19 million shares a day--14% more activity than in December and nearly twice that of November. It was, in fact, the largest daily volume of program trading since September--the month before many of Wall Street’s biggest brokerage houses swore off the most controversial strategy, index arbitrage.

Index arbitrage, which has become increasingly common in recent years, attempts to profit from minute and momentary price differences between stock index futures and the underlying stocks.

The strategy, which is typically used by big institutions that trade in volume, first became controversial 2 1/2 years ago, when it was blamed for worsening the October, 1987, market crash. That 508-point plunge in the Dow frightened many small investors away from stocks. Congress is weighing plans to regulate index arbitrage by giving the Securities and Exchange Commission authority to halt the practice during particularly volatile days.

A handful of brokerage houses suspended index arbitrage trading for their own accounts in late 1987 but continued to transact program trades for clients. However, after October’s 190-point “mini-crash,” many of Wall Street’s biggest firms--including Paine Webber, Shearson Lehman Hutton and Merrill Lynch--were put under such intense pressure from investors that they abandoned the practice altogether, which helped to reduce program trading volume from November to January.

Other firms, including Oppenheimer & Co., and Kidder Peabody & Co., agreed to suspend index arbitrage for their own accounts but continued it for clients.

Still, the spike in program trading activity in January was apparently caused by the unwinding of program trades begun in October and before. Futures contracts often have three-month durations.

“We unwound some strategies in January, so we flipped into the statistics for one reporting period,” said John Ryan, an Oppenheimer spokesman. “But we have not changed our policy” on program trading.

A spokeswoman for Kidder cited similar reasons for the firm’s return to proprietary program trading.

However, Salomon Bros., which also suspended program trading for its own account, said NYSE statistics indicating that the firm conducted proprietary index arbitrage transactions are misleading. The transactions are actually for customers, who needed to sell futures contracts on a foreign exchange.

Salomon would buy the contract briefly, before reselling, which makes it look as if it were trading for its own account when it is actually trading for a client, a company spokeswoman said.

The “unwinding” of October positions was a one-time event, but industry experts said it will probably not be the last time that the market is jarred by program trading.

“It’s something that won’t change unless we ban computers, and that’s nonsense,” said Geraldine Weiss, editor of Investment Quality Trends in La Jolla. “We are in the computer age. We are going to have to get used to volatility.”