Algorithmic Trading Glitch Costs Firm $440 Million

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Algorithmic Trading Glitch Costs Firm $440 Million

Posted by Unknown on Thursday August 2, 2012 @04:48AM from the someone-got-fired dept.

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)."

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Visual walkthrough and commentary of the mayhem by recoiledsnake · 2012-08-02 04:50 · Score: 5, Interesting

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

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1. Re:Visual walkthrough and commentary of the mayhem by Anonymous Coward · 2012-08-02 04:58 · Score: 5, Insightful
  
  Thats unfortunate, but what is more undortunate are the cancelled trades. 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.
2. Re:Visual walkthrough and commentary of the mayhem by alexander_686 · 2012-08-02 06:18 · Score: 5, Informative
  
  It did not. You could be thinking of 2 different things.
  You might be thinking of the Collateralized Debt Obligations (CDO) Market. Here we have swaps that are built on slices of bonds which are built on mortgages. Or, better yet, synthetic CDOs, where are swaps built upon other CDOs. Instead of doing the hard work of evaluating the thousands of underlying pieces people used algorithms to determine the prices – and then the banks used the CDOs as collateral to borrow money to buy more CDOs. The algorithms made bad assumptions about the statistical on defaults. This is a completely different beast – it moves very slow.
  Or, during the same time, a lot of firms that used statistical algorithmic trades (which Knight is) where losing money. They were using computers to shave pennies of trades – basically eating the lunch of the old line market makes. For years they were quietly chugging away making a constant steam of money and all of a sudden they were losing money. The computers worked fine. The markets were in a state of chaos, the underlying assumptions were no longer valid. A lot of them just turned off their computers for 6 months until the market sorted itself out again.
TFA by Anonymous Coward · 2012-08-02 04:53 · Score: 5, Informative

For those not interested in going through all of the links just to find the one that links to the relevant article:
http://www.forbes.com/sites/steveschaefer/2012/08/02/knight-capital-trading-disaster-carries-440-million-price-tag/
Defend flash trading? by Kelbear · 2012-08-02 04:54 · Score: 5, Interesting

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?
1. Re:Defend flash trading? by turkeyfeathers · 2012-08-02 04:58 · Score: 5, Insightful
  
  Millisecond liquidity is substantially superior to having exchanges post transactions in 1-sec intervals because it allows Goldman Sachs to make more money... duh.
2. Re:Defend flash trading? by Genda · 2012-08-02 04:59 · Score: 5, Insightful
  
  What part of wealthy, powerful people with vast computing power screwing the general public do you not understand?
3. Re:Defend flash trading? by Kelbear · 2012-08-02 05:08 · Score: 5, Insightful
  
  To elaborate, I've considered the possibility that, in response to an event, the market's ability to "value" that event takes place as a result of a series of transactions from all participants. For example, a 10 cent stock having a negative press release, and thus a participant wants to sell for 5 cents, and someone else takes that deal, pushing the market price down to 5 cents, while another thinks 5 cents is too low and is willing to buy for 7 cents. pushing it back up, then the first participant changes his mind and buys for 6 cents... Eventually the market settles on a revised price by closing time which has accounted for the "value" of the negative implications of that press release. Thus flash transactions between seconds help find that revised price faster, and the ability of many people to determine appropriate pricing is a valuable thing since it moves capital towards deserving investments which have valuable productivity and society as a whole sees higher productivity and potentially the related benefits.
  But if everyone puts in their guess at 00:00:00, then has to wait until 00:00:01, they will still have all of the relevant positions of market players (the only information that has changed) and can factor that into their 00:00:02 positions. Ultimately, all of those would-be flash transactors will just have to accept the 1-sec interval results as the average of information gained from all the thousands of millisecond transactions that would have taken place right? Basically, I don't think millisecond guesses are any faster than 1-second guesses at finding the true value of an investment. It just takes true analysis out of the picture and brings in the potential for flash-crashes from unsupervised automated trading.
  But I'm just a layman here, I'd like someone with more insight or experience to help me make sense of this.
4. Re:Defend flash trading? by cp5i6 · 2012-08-02 05:50 · Score: 5, Interesting
  
  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.
Why the double standard? by JDG1980 · 2012-08-02 04:57 · Score: 5, Insightful

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...
So if I were to write an auto-trading script using the eTrade API, and as a result of a bug it made bizarre trades and I lost a lot of money, would the NYSE agree to cancel those trades? Didn't think so. Why should the big boys get a second bite at the apple? If you write an algorithm to do trading, then from the POV of the stock markets, that algorithm is you. (Just like the way user permissions work in Unix/Windows.)
Allowing mulligans and do-overs when well-connected firms make mistakes is only going to reinforce the perception that Wall Street is a casino rigged in favor of the rich.
At least the stock analysts are on the job by cpm99352 · 2012-08-02 05:00 · Score: 5, Funny

Today, after the stock dropped 50%, analysts are beginning to downgrade the stock from buy to hold. Excellent analysis there!!!

http://finance.yahoo.com/news/knight-capital-downgraded-hold-buy-155956204.html
Knight really this screwed up... by turkeyfeathers · 2012-08-02 05:06 · Score: 5, Funny

Some programmer's going to lose their job over this error that resulted in a $440 million loss. If the programmer had done the job properly, Knight would have lost $1 billion and been eligible for a government bailout.
Simple solution by nedlohs · 2012-08-02 05:09 · Score: 5, Insightful

Don't cancel the trades. If some idiotic "investment" firm lets a computer program spend hundreds of millions of dollars in seconds then good for them. They get to keep the profits and the losses.
If one of your human trader makes a typo or a computer program has a bug then bad luck, they should have had checks and limits to make sure it doesn't do too much damage to them.
The rest of us don't get do-overs.
Heck just last month I when trying to limp in $2 poker game I picked up two $100 chips and threw them forward by mistake - I didn't get do-over even though everyone at the table new I made a mistake, my $198 raise into a $5 pot plays.
I'm pretty sure if I accidentally typed 100 instead of 10 when making a trade on schwab.com I'm not getting a do-over if the trade completes.
Re:Too bad by cp5i6 · 2012-08-02 05:33 · Score: 5, Informative

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.
Actually, NYSE did tell them exactly that.

Knight is on the hook for the full 440mm USD loss. NYSE stuck them with every single trade that they transacted during the particular time span.

And before you spew the bailouts/ do-overs/hard working american rhetoric, let's actually review the facts related to the topic on hand.

-Knight is a market maker. Their sole purpose on NYSE to ensure liquidity and make money. They do it by actively stepping in to sell and buy particular securities. There is nothing there that "games" the system.
-They rolled out a new application mid week and apparently turned it on without fully testing it causing a huge spike in volume
-The algorithm, rather stupidly, bought high and sold low.
-NYSE actually called within 30 minutes Knight to inform them that they might be accidentally executing incorrectly
-Knight basically ignored the warning and let the algorithm run for a full hour.
-End of the day, Knight is on hook for the entire loss. Not because it was a "mistake" but because these are all legitimate trades with legitimate counterparties and didn't violate any rules.
-Nyse has stated that and has said there would be no further appeals allowed on the issue.
Re:Moral Hazard by alphred · 2012-08-02 06:34 · Score: 5, Insightful

Dude, it's Wall Street. They don't have to live with consequences.
Re:HFT for dummies by cpm99352 · 2012-08-02 07:12 · Score: 5, Informative

The problem w/ HFT is buy/sell orders get placed and then immediately (less than a second later) cancelled. The HFT algo puts out the trade with no intent of actually executing the trade.

That is a violation of the rules, but strangely enough, the SEC sees no need to take action.

It is also questionable if the HFT algo actually has the cash on hand behind the order at the time the order is placed.

The idea that HFT injects liquidity is up for debate, as we see the HFTs turned off at times of crisis. Thus, no one will step in to backstop the market. Otherwise if the HFT were working to ensure liquidity there would be no such thing as a flash crash.
Re:HFT for dummies by johnjaydk · 2012-08-02 07:33 · Score: 5, Insightful

First, the added liquidity from HFT market makers are largely fake. They cancel 90 percent of their orders before they are executed.
Second, these market makers trade at a discount at the exchanges due to the maker-taker deals. This tips the playing field in their favor.
Third, HFT outfits utilize special order types that are moved to the front of the execution queue and therefore they can do front running on a massive scale. This causes regular buyers and sellers to take a hit.
HFT is such a dominant force in the equity market that it amounts to 75 percent of all US stock trades. This have caused the the average time that an investor holds a stock to drop to 11 seconds. With those numbers, the consequences for volatility are pretty obvious.
The best part is that the exchanges are in on the scam and are beholden to the HFT outfits least they take their business elsewhere.
All of this comes out of Your 401(k) and other long term investors not to mention the damage to the economy at large. Companies are already backing away from raising capital in the stock market because it's so obviously rigged. Likewise, investors are moving into dark pools in order to protect themselves from excessive front running.

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Re:Moral Hazard by ShanghaiBill · 2012-08-02 09:17 · Score: 5, Insightful

Still think they should let all the trades stand?
Yes! Anyone dumb enough to use a "stop-loss" order deserves what they get. If you invest in a company, it should be because you think it is worth more than its current valuation. So why would you want to automatically sell it if the prices goes even lower? If the price goes down, you should logically want to buy more, not sell what you have.
Anyone using stop loss orders does not understand the purpose of investing, and should not be investing in individual stocks.