Nowadays, there’s
lots of algorithmic trading in the markets which is generally responsible for short-term moves. When you see quick spikes in the price, that generally
happens because of algos. These are automatic algorithms that are programmed to
identify opportunities in the market based on certain inputs and are almost
always the first to move the price.
There are even
algos programmed to exploit other algos. Some examples of these algos in play
is when you see big sudden spikes in the price as a news or economic report
hits the newswires. This happens regularly and the trick is to identify when the
reaction is right or wrong.
Algos don’t have
the human foresight (not yet at least). There are many cases of them moving the
price in the wrong direction. For example, when an economic report gets
released and looks good on the surface, but its details are bad.
In such cases, you
would see a spike in the direction of the good-looking headline but then a fade
of the move later as the real money starts to trade in the opposite direction.
Sometimes though they are right, and for a day trader the tricky part is that
they may have already moved the price for the average daily range. In such
instances, you might see a pullback before another wave in the direction of the
spike.
Knowing this can
help you fade the algos reaction as per your individual bias when you think the reaction is wrong-footed and enter at better prices or join the
momentum that’s going to be created if the reason is in line with the
fundamental direction.
Some other
examples of short-term spikes can include what is called a “fat finger”. That’s
when some large institution enters the market with a huge size by mistake and
immediately closes the position. Other times it may be just a low liquidity time
and a too much big order may not find counterparts near its price causing the
price to move more than usual and some algos might exacerbate the move because
of some momentum inputs.