THE HOMO FISCUS

INSPECTING OUR ECONOMIC CONDITION

Knight Capital: Dangers of Algorithmic Trading

(Reuters)

NYT – An electronic trading “bug” Wednesday, August 1st caused financial trader Knight Capital Group to lose $440 million in the markets and caused its shares to drop 63 percent. DealBook’s Nathaniel Popper reports on the circumstances:

The problem on Wednesday led the firm’s computers to rapidly buy and sell millions of shares in over a hundred stocks for about 45 minutes after the markets opened. Those trades pushed the value of many stocks up, and the company’s losses appear to have occurred when it had to sell the overvalued shares back into the market at a lower price.

The company said the problems happened because of new trading software that had been installed.

This episode is especially reminiscent of the Flash Crash of 2010 in which an errant algorithm caused the largest single-day point decline in the DJIA. With a market increasingly computerized, these incidents illuminate the potential consequences of algorithmic trading. More so, it has analysts wondering if Wall Street is broken as it vacillates on the whims of even the smallest algorithmic mistakes. It has the nation wondering when that single computerized glitch will wreak the final blow and bring our financial systems tumbling. It even has some accepting that such glitches are the nature of our financial system, and that the trading apocalypse is simply a dramatization.

However, more are wondering what exactly caused this glitch. Felix Salmon of Reuters offers some interesting analysis:

Still, there is one likely cause for what happened. When you zoom in and look at the trades at intervals of less than a second, it starts to look like a new NYSE trading system may have been involved. Stephen Gandel has an explanation of the NYSE’s “Retail Liquidity Program”, which launched Wednesday and which uses “algorithms to figure out when it makes sense to offer a slightly better price than what others are offering, and snatch up stock trades, this time away from Knight and others”.

If the RLP is what caused Knight’s losses, the NYSE may have fatally wounded both a competitor and its own reputation.

Ultimately, if an algorithmic error can bring Knight Capital to the ground, potentially permanently, then it is reasonable to assume that an error exists that can bring down Wall Street. As the CEO of Knight Capital succinctly puts it, ““Technology breaks.”

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