Commentaries

SEC’s flash in the pan

Securities regulators will often settle for the proverbial low-hanging fruit — prosecuting easy cases that don’t make a big difference in the way Wall Street operates. But it does give the appearance they’re doing something.

And so it is with the Securities and Exchange Commission’s proposal to stamp out flash trading, an unsavory practice that has permitted some high-frequency trading desks to get a millisecond sneak peak at market trade orders.

Banning flash trading certainly makes sense, because there’s no reason that trading firms with lightning-fast, computer-driven buy and sell programs should get an advantage over the rest of the market.

But the furor over flash trading has always been something of a sideshow because it affects a minuscule percentage of the tens of millions of high-frequency stock trades made each day.

There’s reason to worry that after cracking down on flash trading, the SEC will consider its work largely done. Mary Schapiro, the commission’s chairman, says regulators are taking a hard look at a wide range of “market structure issues,” including high-frequency trading. But Schapiro has offered few specifics and largely spoken in generalities on the subject.

Schapiro hasn’t said much publicly on the two main criticisms of high-frequency trading: its ability to add unnecessary volatility to the markets, and its potential to spark a market meltdown because so many computer programs employ the same algorithmic strategies.

And Schapiro’s silence on the matter could leave one wondering just how rigorous this SEC review is going to be, and whether the ban on flash trading is all that regulators plan to take on.

Algos gone wild

The many proponents of high-frequency trading keep saying there’s no reason to be concerned about a rogue algorithim sparking a 1987 market-style crash. HFT supporters keep saying show us a case where a rogue algo even caused a minor hiccup in the market.

Well, Bernard Donefer, a professor at CUNY’s Baruch College in New York City and a critic of highly-automated trading programs, says the world already has gotten a glimpse at the kind of mayhem a rogue or simply a misfiring algo can cause.

Donefer, in a soon to be published research paper, blames high-frequency traders and an algo gone wild for a bizarre $9 drop in United Airlines’ stock on Sep. 8, 2008. The sudden plunge in UAL shares wiped out $1 billion in market value in just 12 minutes, after a six-year-old headline about the airline filing for bankruptcy erroneously hit some news wires.

The airline’s stock quickly recovered after it was determined that the bankruptcy story was an old, old story. But Donefer argues the percipitous drop in UAL shares “was mostly the result of the interplay between the algorithms that search and compile information from the Web and the ones that Wall Street firms and hedge funds use to make trades automatically.”

This is an isolated case, but Donefer says it’s only a matter of time before an event like the UAl one–or a series of events in which algos go wild–sparks a widespread market crash.

Will we see an event caused by algos gone wile in our markets? I believe it is inevitable. I am further convinced that with no planning…or regulatory framework it will be hard to stop. With unfettered or naked access, it might impact the viability of a broker.

This is the doomsday scenario I wrote about in my column Wall Street meets The Matrix. It’s also the kind of computer-driven catastrophe that the folks at Zerohedge.com and Joe Saluzzi of Themis Trading have been warning about.