Two years after a catastrophic financial collapse and six months after the passage of a Wall Street reform bill, astonishing tales of volatility in the market are all too common. If you think inexplicable flash crashes are worrisome, brace yourself for the next big financial "innovation" –- Twitter Trading.

Wall Street computers are beginning to analyze and trade on a wide array of media sources –- without human intervention. Graham Bowley from the New York Times has done a series [3] of articles recently on high-speed trading that are a must read. From the Times:

Math-loving traders are using powerful computers to speed-read news reports, editorials, company Web sites, blog posts and even Twitter messages – and then letting the machines decide what it all means for the markets. In some cases, the computers are actually parsing writers’ words, sentence structure, even the odd emoticon. A wink and a smile :-) for instance, just might mean things are looking up for the markets. Then, often without human intervention, the programs are interpreting that news and trading on it.

Mad Money

For those of us who might be worried about thousands of computers making millions of trades based on how many times Mad Money’s Jim Cramer has "Booya" in his Tweets, have no fear. The issue has been subject to rigorous academic scrutiny.

A paper [4] by the University of Manchester and Indiana University published last October said the number of emotional words on Twitter could be used to predict daily moves in the Dow Jones Industrial Average with 87.6 percent accuracy. The researchers found it useful to use the Google-Profile of Mood States (GPOMS) that measures mood in terms of six dimensions (Calm, Alert, Sure, Vital, Kind, and Happy). Apparently, "Reckless" and "Trigger Happy" were not options.

The researchers found that the "public mood" deduced from Twitter and Google is a leading indicator for the Dow, and not the other way around. Analysis of calm vs. anxious states can predict what happens with the Dow a few days out and give an edge to media-obsessed traders –- that is, if real humans are actually analyzing the data flow.

Major news providers Dow Jones and Reuters [5] offer news products that archive and structure news to provide machine-readable feeds for use in trading algorithms. This enables large-scale trading with little human screening. The market for unstructured data is also big. The New York Times reports that about 35 percent of quantitative trading firms are exploring whether to use unstructured data feeds of news, blogs and tweets. Two years ago, only about two percent of those firms used them.

Gee, unstructured news plus Tweets feeding directly into trading algorithms ... what could go wrong?

Halt the Arms Race

Information is the most valuable commodity on Wall Street. Traders with the best information and fastest computers can make a killing. "It is an arms race," Roger Ehrenberg, managing partner at IA Ventures, told the Times [3]. But trading based on public mood swings as evidenced by Twitter and Google is taking the arms race to a whole new level.

About seventy percent of Wall Street trades already qualify as "high-frequency." Computers buy and sell shares up to 1,000 times faster than the blink of an eye often with little human forethought and intervention. Some of this is "noise trading" –- ill-informed investors simply following the stampede. Now we will have "Twitter trading" –- sure to lead the cattle off the cliff.

In an era of inexplicable flash crashes, reckless commodity speculation on gas prices and "too-big-to-fail" taxpayer guarantees backstopping much of this activity, do we really need to be trading on Tweets?

There is an easy way to halt the arms race. An increasing number of world leaders, business leaders, organizations, and economists are calling for a financial speculation tax. [6] Even a modest tax of .25 percent on stocks and other trades based on transaction costs would crimp the style of high-volume high-speed traders by raising the cost of each transaction and forcinf the traders to ground their activities in some rational thinking. Plus, it could raise an astounding $100 billion a year that could be put to use creating jobs or preserving essential public services.

The Nation magazine recently [7] dubbed a financial speculation tax "the best legislative proposal of 2010." Give those Wall Street boys a headache and Tweet it today.

Track big bank shenanigans at BanksterUSA.org. [8]