A word on last week’s panels in KC (see Dick Johnson’s write-up at his superb blog) and NYC about modern trading: Had a great time in KC and felt we effectively explained how different time horizons and purposes, combined with lots of passive market-making, affect stock prices today. In NYC, it was a bit frustrating. We started in the middle and never got out of the maze. Sometimes the magic works, sometimes it doesn’t.

Speaking of the maze, you hear the term “program trading” often. Did you know that every other purpose for owning your stock may be overwhelmed by programs? It’s important to know their effect on your stock, and what’s behind them.

The NYSE defines programs as system-driven orders in 15 or more securities totaling more than $1 million. Every Friday, there’s a blurb in the Wall Street Journal on it, and Friday January 22, it was 27.6% of volume on the Big Board, up quite a bit from the week before.

We view program trading a bit differently because markets have radically evolved since the NYSE defined program trading that way. To us, managed, multi-day, multi-stock order-execution is program trading. Stripping out the jargon, we cluster execution by its behavior, and if it’s being managed to fit volume, and it’s happening over multiple days in more than one issue, it’s program-driven. We miss some, but not much. By our measure, program trading on the Big Board averages over 50% of volume, and a bit more than that on the Nasdaq.

This river of liquidity is the lifeblood of the equity markets. It balances out mutual fund inflows and redemptions, it rebalances ETFs and asset-allocation models and pension and sovereign-wealth funds, and it tweaks portfolios according to market risk. Just a few years ago, it had the flavor of investment value. That is, data on financial performance played a big role in its behavior. Today, those things take a back seat to market risk, an eyelid-drooping term that means “what can screw up my portfolio performance today?”

The markets have changed a lot. Shares for meeting the needs of these constantly swirling programmed waters are harder to locate. There are many intermediaries, and pockets of liquidity tucked into corners, and everything is affected by everything else. Morgan Keegan executes a sell order for a conservative investor in bank stocks, and over in tech equities, the trades trigger rebalancing in leveraged ETFs.

While any little thing can affect trading now (that’s a separate discussion), and high-speed, low-cost execution cloaks some massive inefficiencies in our markets when it comes to re-locating liquidity of any size at all, everything depends on the river. If we don’t have good, healthy program trading, the risk climbs for everybody, and prices move inversely to risk.

During expirations last week, we had a massive, program-led dislocation in the markets stemming from a steep rise in the cost of portfolio insurance, reflected in the pricing of various hedges. So money sold equities to reduce risk, and bought derivatives as insurance. Result: markets crumbled by hundreds of points. This is the truth. We can see it in the data. Anything else is peripheral to risk-management right now.

And here’s what keeps Ben Bernanke up at night, we surmise: half the volume in the equity markets is dependent on program trading. Most of that volume is driven by a handful of very large banks. Liquidity is now being withdrawn from the banking system. Mortgage-backed securities auctions, which have a big impact on other asset classes including equities in programs and which are led by the same banks, are ratcheting down.

If program trading starts falling, risks rise in the markets. This is a delicate balancing act for monetarists. And of course, if something other than supply and demand or buying and selling is setting prices, then the market isn’t really free.

We’re moving the Market Structure Map to a blog, to invite comments (so please comment!). Don’t worry, we’re not about to start tweeting. But I do like the interactivity at the blog. We’ll dual track with the email awhile, then move to alerts about the weekly post.

In the Michael Jackson movie “Just Do It,” the legend is backed by a cadre of dancers in one scene, who, through “green screen” technology are replicated so that it appears to viewers to be a vast dancing army.

Vast Dancing Army would be a good name for a rock band. And Green Screen might be at work in the equity markets. Is trading real, or replications that create an illusion meant to mimic reality?

It’s an important question. Ben Bernanke said yesterday:”We use our interest rate tools to try to meet our mandate — full employment and price stability.” A tagline on the European Markets WSJ update today read: “Traders said stock-market sentiment remains positive, buoyed by rising faith in a global economic recovery.”

The Fed can’t prestidigitate jobs, resulting in full employment, or magically materialize price stability reflective of balanced supply and demand. It can only toy with monetary tools to produce a facsimile of that outcome in the behavior and availability of money. Markets can only reflect whatever factors affect the behavior of money.

So, do markets reflect rising investment and production, or just a facsimile thereof? And if so, what’s that mean to your stock price a week or a month or a year from now? These are the questions that matter to IR. Alas, monetary factors, and the traders’ responses to them, carry more weight at the moment than your business fundamentals.

Here’s an example. On November 12, we saw a marketwide hedge reset in equities. Quite literally, it was a seismic ripple through every shape, size and form of equity. Institutions use risk-management systems and software to modulate risk relative to economic factors and monetary policy. These systems use the same data, so the effects are similar. And they invariably happen ahead of options expirations, occurring this week.

Electronic trading is initiated to rebalance mixes of securities. Not just equities, but other instruments ranging from debt to treasuries, to commodities (which can now be traded daily in Exchange Traded Commodities vehicles), and currencies (which can also be traded in ETCs). So on Nov 12, these assets were tweaked. On Nov 16, when LEAPs – long-term market futures – converted, institutional asset managers did not renew their portfolio insurance at the same levels, and instead put some money into equities.

Boom, the market shot up. We saw the same thing around LEAPs expirations on July 13. It’s eerily similar.

The question is: what’s real? Is this a response to fundamentals, or a reaction to monetary policy?

The data tell us it’s a Green Screen. We’ve seen aggressive fundamental money in the markets recently. But on the whole, volumes are muted. Electronic volumes were way up – but part of that is risk management and part is money that’s been on the sidelines and is now desperate to make up for lost time before year-end.

On the whole, the stuff that’s given us 60% gains in the market this year – hedge fund traders and gigantic prime programs using free money – is shifting out of the markets. Goldman Sachs, we’ve noticed, is trimming volumes on its trading desks. There is a dearth of “commission recapture” execution, or trades that occur in response to research. Active money hitting markets on electronic platforms is tactical, not strategic.

We follow data. The data suggest that there’s less here than meets the eye.