Computer trading producing new financial dynamics?

In October 1987,  stock markets around the world crashed, with the Dow Jones droping 22%.  The causes of this crash are still unclear, but one of the suspected causes was computer automated trading.  This concern lead attempts to design mechanisms to break potential viscous cycles by creating ‘circuit breakers‘, rules that halt trading if the Dow rapidly .  However, as financial engineers innovate, new risks are emerging.   The Financial Times writes Computer-driven trading raises meltdown fears:

An explosion in trading propelled by computers is raising fears that trading platforms could be knocked out by rogue trades triggered by systems running out of control.

Trading in equities and derivatives is being driven increasingly by mathematical algorithms used in computer programs. They allow trading to take place automatically in response to market data and news, deciding when and how much to trade similar to the autopilot function in aircraft.

Analysts estimate that up to 60 per cent of trading in equity markets is driven in this way.

… Frederic Ponzo, managing partner at GreySpark Partners, a consultancy, said: “It is absolutely possible to bring an exchange to breaking point by having an ‘algo’ entering into a loop so that by sending them at such a rate the exchange can’t cope.”

Regulators say it is unclear who is monitoring traders to ensure they do not take undue risks with their algorithms.

The Securities and Exchange Commission has proposed new rules that would require brokers to establish procedures to prevent erroneous orders.

Mark van Vugt, global head of sales at RTS Realtime Systems, a trading technology company, said: “If a position is blowing up so fast without the exchange or clearing firm able to react or reverse positions, the firm itself could be in danger as well.”

For more details on current problems see the Financial Times article Credit Suisse fined over algo failures

NYSE Euronext revealed on Wednesday it had for the first time fined a trading firm for failing to control its trading algorithms in a case that highlights the pitfalls of the rapid-fire electronic trading that has come to dominate many markets.

The group, which operates the New York Stock Exchange, said it had fined Credit Suisse $150,000 after a case in 2007 when hundreds of thousands of “erroneous messages” bombarded the exchange’s trading system.

Asked if the exchange’s systems could have been knocked out, he said: “If you had multiplied this many times you’d have had a problem on your hands.”

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