A while ago in a piece named "Rise of the Machines" I suggested that automated algorithmic trading systems were a problem waiting to happen. Sadly this was wrong because the problems had already happened. As this article from the Financial Times shows, these systems had been misbehaving even before Wall Street freaked on May 6th 2010. What's really worrying, though, is that the FT article poses the question: "…has technology reached the point where machines pose systemic risks if they go berserk?" The answer's pretty obvious to anyone who's ever crafted a program more complex than the obligatory "Hlelo wrold" initiation, but perhaps the leaders of the financial world are really IT illiterates? Just in case, here's a primer.
Crazy Code?
Remarkably the causes of the calamitous drop on Wall Street on 6th May still aren't entirely understood. It's a tad worrying that no one quite knows why the Dow collapsed 1000 points, a gut-wrenching 9.2%, in less than an hour before recovering almost as rapidly. Proctor and Gamble stock fell 37%, Apple 22%, Accenture 99.9% ... the list goes on.
One theory is that it's something to do with the automated trading systems that have increasingly come to dominate markets. The suggestion is that the NYSE's circuit breakers inadvertently caused the problem. Basically when markets start to move suddenly and erratically the NYSE has the power to call a time-out, to allow buyers and sellers to re-establish a common position. However, this had an unexpected side-effect, because the trade-bots live in their own world:
"The rest of the markets are free to trade around us," said NYSE CEO Duncan Neiderauer, "and that's what they did." So, as the NYSE paused for a minute or two at about 2:40 p.m. ET, the off-exchange computers kept searching to execute trades. They hit the best bids still standing, which in many cases were far below the prior price. And in some cases, the off-exchange computers found no bids at all. When that happens, market-making computers see a zero bid, then offer a penny higher to capture the trade and collect a commission -- hence the trades of just one cent for several stocks ...
Put a human in an unexpected position and they may use their judgement to deal with it. Surprise a bot and, much like a politician faced with irrefutable evidence they've…
