Computer-based trading under scrutiny in Dow freefall

07 May 2010 | 9787 views | 1 ticker 2

US regulators are scrambling to deal with the aftermath of a wild day of trading on the Dow Jones Industrial Average which shipped more than 600 points in seven minutes before the close of trading in New York.

The sickening lurch in the Dow caused scenes of chaos in US markets as computer-based programs kicked in and exchanges and currency markets struggled to handle an unprecedented surge in volumes.

The panic spilled over into other markets as investors fled for the safety of government bonds cuasing yeilds to drop and pushing the dollar sharply higher.

US regulators are undertaking a forensic investigation of the day's trading in an effort to pinpoint the cause of the collapse as exchanges move to cancel obviously erroneous trades.

Nasdaq issued a statement saying it would cancel all trades executed between 14:40:00 and 15:00:00 that showed a 60% swing in price during the peak trading period.

"There is no indication at this time that a Nasdaq market participant experienced a technological failure in connection with this event," the statement continued.

The Chicago Mercantile Exchange also felt moved to responded to rumors concerning irregular trades by Citigroup in stock index futures: "While our policy is not to comment on individual participation in our markets, in light of volatile market conditions, CME Group confirmed that activity by Citigroup Global Markets Inc. in CME Group stock index futures markets does not appear to be irregular or unusual in light of market activity today."

Whatever the cause, the freefall in the markets will stoke up regulatory concerns about the role played by high frequency traders and automated trading progams in the ensuing market meltdown.

Giles Nelson, chief technology strategist of Progress Software, gives the vendor perspective: "Unfiltered access to trading destinations can end up causing trading errors or even a 1000 point crash on the Dow Jones Industrial Average. This is why pre-trade risk management tools are absolutely essential - to monitor position limits, trading limits and to catch fat fingered errors before they happen. Banks and regulators must act to stop this happening. It is completely avoidable."

Finextra verdict Much of the probing into the crash of 2.45pm (as the event's being dubbed) is centred around a sudden plunge in the value of Proctor & Gamble stock, which dropped from about $62 to $39.37 in a matter of minutes. It seems the machines sent off wave after wave of sell orders into a vacuum as high frequency trading programs pulled back in response to the sudden volatility. Indeed, some HFTs such as Tradebot Systems simply shut up shop for the day. The HFT's routine defence against regulatory restrictions is that they provide a valuable source of liquidity during times of extreme market distress. This deep well of liquidity suddenly seems a little shallow. The HFTs failed the market on Thursday, for which they may pay a heavy price. Expect more clampdowns in the near future.

Comments: (1)

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Elton Cane - Independent - Brisbane | 07 May, 2010, 12:51

Citi is denying it, but The New York Post and WSJ are reporting rumours that a Citi trader executed a trade for $16 BILLION, instead of $16 MILLION in e-mini shares that track the perfomance of the S&P 500 index. Easy mistake to make one would think - a few extra zeros, or a B instead of an M. Certainly one that any pre-trade risk management at the broker, and ideally at the exchange too, would pick up.

But if CME says the Citi trades didn't look unsual in light of market activity, perhaps this $16b trade was an algorithm's response to an unintended trigger elsewhere.

Some reports are pointing to the rapid drop in share price of Proctor and Gamble and 3M on NYSE and Nasdaq as the culprit that sent the algos scrambling. But I haven't seen any reports yet on what may have triggered those plunges.

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