The NYT reports that “Computer Trades Are Focus in Wall Street Plunge:”
Investigators seeking an explanation for the brief stock market panic last week said Sunday that they were focusing increasingly on how a controlled slowdown in trading on the New York Stock Exchange, meant to bring about stability, instead set off uncontrolled selling on electronic exchanges, Graham Bowley and Edward Wyatt write in The New York Times.
It was an unintended consequence of a system built to place a circuit breaker on stocks in sharp decline. In theory, trades slow down so that sellers can find buyers the old-fashioned way, by hand, one by one. The electronic exchanges did not slow down in tandem, causing problems, according to two officials familiar with the investigation. (The Street also named a Chicago company that services hedge funds as being behind some of the unusual trading, a charge that the company denied.)
That could mean that the computers first flooded the market with sell orders that could not be matched with buyers. Then, just as quickly, many of these networks withdrew from trading. The combined effect might have set off a chain reaction that sent shares of many companies spiraling during the 15-minute frenzy.
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It is not known exactly what caused the initial sell-off in the blue chips, but investigators say the earliest sign of trouble they have found was a sudden drop in the value of a futures contract on the Chicago Mercantile Exchange, based on the Standard & Poor’s 500-stock index. That pushed down a broad array of stocks in that index, all of them traded on the New York Exchange and other major exchanges, and sent many stocks on the New York Exchange into slow mode.
Ever since computerized trading became dominant in the nation’s stock markets in recent years, market experts have been warning that the lack of consistent rules among exchanges and the increasing complexity and speed of computer trading systems could destabilize markets. This appears to have happened last Thursday, when stock prices plunged and the Dow Jones industrial average fell roughly 600 points in a few minutes.
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Investigators are now focusing on the events of last Thursday, when several hundred stocks on the Big Board, including five major stocks that make up the Dow — Accenture, Procter & Gamble, 3M and two others — went into slow mode.
This decision forced a switch to slow-motion trading as traders on the floor tried to arrest the decline by manually seeking out bidders. But that did not work, because trading shifted immediately to broader markets controlled by computers, where the plunge continued.
Regulators and the exchanges continued over the weekend to review the tapes from the millions of trades made last Thursday. The investigations are looking at what effect the decision to halt trading in these stocks in New York had on broader market confidence — and on algorithms used by computerized traders.
The scale of the shutdown on may have been a new phenomenon for these computer systems. They may also have been programmed to shut down in such a cataclysmic moment of stress, which would have had a further cascading effect in withdrawing bidders from the market and putting further intense downward pressure on prices.
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The S.E.C. has been warned in recent months by market participants, publicly traded companies and other regulatory agencies that the lack of coordination between trading platforms, as well as the expansion of high-speed trading in alternative markets, has furthered systemic risk, encouraged regulatory arbitrage and increased opportunities for market manipulation.
The staff of the Financial Industry Regulatory Authority wrote to the S.E.C. in April that “no single regulator has a full picture of all trading activities in the U.S. equity markets.”
[Emphasis added]
While this is very interesting, it remains to be seen if the S.E.C. will now actually step forward and address this issue to prevent a recurrence in the future. The people who were most hurt in this one day breakdown were those who had placed their sell stops ahead of time and got filled at far away (undesirable) prices.
Why? Remember, you can place a sell stop at a limit price but, once that price has been reached, your order becomes a market order and who knows what price you will get in a fast moving market. I discussed these issues and others in “Front Runners.”
This is one of the reasons why I have been harping on using day-ending prices only to determine whether your sell stops have been triggered or not. If they have, only then should you place the order to sell the next day after the market has opened.
This eliminates front running and getting caught in a huge market downdraft. There are only a few things you have control over when investing; this is one of them, so use it and increase your chances of not falling prey to vagaries of Wall Street.