Algorithmic Trading Glitch Costs Firm $440 Million

alstor writes "Yesterday an update to Knight Capital Group's algorithmic trading software caused massive volume buys and sells, resulting in large price swings on the New York Stock Exchange. As a result, the NYSE canceled some of the trades, but today the loss to Knight has been calculated at $440 million. Ignoring adjustments for inflation, this makes the cost of this glitch almost as much as the $475 million charge Intel took for the Pentium FDIV Bug, which might warrant adding this bug to the list of worst bugs. In light of this loss and the May 6, 2010 Flash Crash, perhaps investors will demand changes from firms using algorithmic trading, since the SEC is apparently too antiquated to do anything about it (PDF)."

Comments

Visual walkthrough and commentary of the mayhem

[recoiledsnake]

Here http://www.youtube.com/watch?v=dOO9XxH5Nyo&list=UU6NBj2q25QL4kN8tqwU9c-A&index=2&feature=plcp

Re:Visual walkthrough and commentary of the mayhem

[fuzzyfuzzyfungus]

This feature is by design.

Re:Visual walkthrough and commentary of the mayhem

[0123456]

Without the full downside risk high frequency trading takea on an appearance of a club where the superrich bilk regular imvestors and tilt the playing field in theor own favor.

Like the rest of the stock market, you mean?

Re:Visual walkthrough and commentary of the mayhem

[HeckRuler]

You're reading that wrong. It's not just "nice" being rich, the "advantage" that the previous coward was talking about is a competitive advantage. They're not playing by the same rules you and I are. It's a bias in the game that favors them. It's systematic cheating. I agree with you that there are rich scumbags who didn't get there honestly. But regardless of how they got rich, the rich aren't (generally) making their income honestly. And that's at our expense. All that money comes from somewhere. The financial industry does not generate wealth. Monopolies, oligarchies, back room deals, and "take-backs" on stock exchanges, these are failures of the free market. They're playing the big business game, and you and I aren't allowed in.
(Unless we all team up to form an even bigger and more powerful zoid that forces them to play nice)

Defend flash trading?

[Kelbear]

A common defense of flash-trading is that it provides market liquidity in that it provides counterparties to the desired transactions of the rest of the market.

But I've yet to see someone discuss how the added-value of millisecond liquidity is substantially superior to having exchanges post transactions in 1-sec. intervals to discourage millisecond arbitrage during which no new events have occured and no new market analysis has taken place, only speculation and playing the system against proper investors? Can someone illuminate me on this point?

Re:Defend flash trading?

[cp5i6]

This is also where Knight's algorithm potentially screwed up.

usually firms will put in limit orders. ie I believe it's this so therefore don't go above or below that target to transact

Also what you are missing is that NYSE just "matches" trades. 1 second "guessing" ignores that fact that no matter what you guess, if there is no match, there is no trade. And since not all the market makers enter their prices at the same time, not everyone waits around at the same time.

here's an exaggerated example
Take enron when they released their financial misreporting scandal.
Imagine if every one had to wait 1 hour before prices get updated and transacted.
The stock was at 72$
Everyone in the world just puts in a short @ 72$ because we ALL know what's goign to happen to this stock
At the end of the hour, every one and their extended relatives has shorted Enron @ 72$.
Now, as the exchange, what gets executed? Chances are, nothing. All those buyers on the other side already knew that 72$ is a terrible buy and would have all pulled prices. You now have 0 liquidity.

Too bad

[sanosuke001]

I'd tell the firm "too bad". It shouldn't be up to the NYSE to make sure companies don't do something stupid. Back in time a ways, when someone tried to game the system and then failed hard they would be ignored and forgotten. Now, with bailouts and do-overs and participation trophies, we ignore hard working americans who don't expect handouts and reward those who don't want to take responsibility for their actions.

Re:Why the double standard?

[ranton]

On the other hand, those accidental sells significantly affected the price of certain stocks. If you are an average investor holding onto one of those stocks, wouldn't you rather the trades were canceled so you didn't take a bath due to someone else's error?

If you just randomly bought a stock whose price went up over 30% in 45 minutes (the criteria they used to determine which trades to cancel), then it your own dumb fault that you lost money. Anyone who was holding onto these stocks were not greatly affected, because the prices already returned to normal after Knight Capital Group had to sell those inflated stocks back.

Re:HFT for dummies

[citylivin]

"The problem is that once they locate the buyer and seller, they need to buy the stock from the seller first, then turn around and sell it to the buyer, but the buyer may have cancelled they transaction"

So what value are they adding? Seems like you are describing a useless middleman which uses computers and enormous wealth to stand in the way of two parties negotiating on a price. The middleman does not intend to invest in the company that they are trading, they are just skimming off the top. This drives up the price for everyone, and makes money for the middleman. Why is the exchange itself not matching up buyers with sellers? why do we need these third party traders doing it? Surely a computer can take a sell price and match it up with someone who wants to buy it. Why have the middlemen artificially inflating the price automatically? You seem to be saying that these people should not have to incur any risk in that 1 or 10 seconds. Why? they are gambling with no risk, if their trades always go through and they always inflate the prices people pay, and rip off the sellers.

Sounds like common sense to me. Society as a whole should be working to eliminate middlemen, people which add no value. Why by a car from a dealership when you can order it on the internet for a fair price (the same as everyone else would pay) with no negotiation required.

Re:HFT for dummies

[rundgong]

... they are market makers. They find a willing buyer and a willing seller ...

Then they are not making any markets. It's not like the real buyer and seller wouldn't find each other if the HFT was not there. It's just that they would find each other a millisecond later.
All they do here is steal some profit from the real investors. If the buyer is willing to buy at 3 and the seller is willing to sell at 1, they should meet at 2. Not give the difference to the man in the middle who happened to have a shorter network cable in the stock exchange server room.

Since the introduction of high frequency trading, transaction costs have fallen considerably, saving plenty of people a lot of money.

I would say you have confused correlation for causation.
Computers getting faster and cheaper have made transaction costs go down. HFT just happened to grow big at the same time.

Now, let me turn the question around. What is wrong with high frequency trading? Other than people ranting about something they have made no effort whatsoever to understand, I haven't seen a single good argument against it.

Thats exactly what I was thinking about people arguing for it. I have never heard a single good argument for it.
The real investors don't benefit, and the companies don't benefit either. But hey, the man in the middle makes a fortune until he crashes the market, so that's gotta be worth it, right?

HFT was originally blamed for the 2010 "flash crash" but the full investigation found that HFTing actually made is less severe.

I have never heard of this before, but I am very interested in a citation so I can read more about it

This was not algorithmic trading.

[JazzHarper]

Contrary to TFS, Knight was not running algorithmic trading. They are a "market maker" for retail brokerages, like Fidelity, Vanguard, E-Trade and, in particular, Scottrade. (About 40% of Scottrade's traffic was going through Knight). The NYSE had just brought a new retail trading interface on-line, and Knight's software did not conform correctly to the protocol. As a result, it kept re-entering the same orders, over and over. These were small retail orders, just a few hundred shares each, but they were submitted to the exchange thousands of times.

The two outstanding questions are: Why was their interface not tested properly and why did it take them over 30 minutes to pull the plug?

Re:HFT for dummies

[sjames]

Imagine If I walked around the grocery store and every time someone went to take something off the shelf I knocked them down and cleared the shelf. After they leave in frustration, I sell them what they wanted for a slightly higher price. If they say no, I toss the food back on the shelves and tell the grocer "just kidding!". I am a high speed grocery trader!

For some reason, the cops don't arrest me. Perhaps because they know that if they look the other way, I might hire them for more than they will ever make as a cop.