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Bloomberg Echoes looks at the history of computer driven snafus:

When machines replace seasoned traders and market makers, mistakes can occur at dizzying speed. It happened with the notorious “flash crash” on May 6, 2010, and again on Aug. 1 this year, when software at Knight Capital Group Inc. (KCG) malfunctioned, triggering unintended trades and leading to a $440 million loss for the company.

Ironically, Knight Capital Group was originally known as a market maker, with trading specialists who oversaw trades on each side of a security to ensure the market functioned in an orderly and efficient manner. The company’s troubles once again show the extent to which Wall Street now relies on algorithmic programs to execute its trades, for better or worse.

Although many in the financial world have expressed concerns that a new era of automated finance is destabilizing the markets, algorithmic trading isn’t new — it’s almost as old as computers themselves . . . Algorithmic trading soon evolved into nanotrading. In the signal extraction world, a second is an eternity. An algorithmic-trading facility located within a block or two of the New York Stock Exchange (NYX)’s servers could see trade data a millisecond sooner than a trading facility half a state away. A modern computer can execute millions of calculations in that millisecond. Such signal theory and nanotrading soon required that humans were all but removed from trade execution.”

The entire article is worh reviewing.

 

Source:
History of Algorithmic Trading Shows Promise and Perils
Colin Read
Bloomberg, August 8, 2012
http://www.bloomberg.com/news/2012-08-08/history-of-algorithmic-trading-shows-promise-and-perils.html

Category: Markets, Quantitative, Trading

Please use the comments to demonstrate your own ignorance, unfamiliarity with empirical data and lack of respect for scientific knowledge. Be sure to create straw men and argue against things I have neither said nor implied. If you could repeat previously discredited memes or steer the conversation into irrelevant, off topic discussions, it would be appreciated. Lastly, kindly forgo all civility in your discourse . . . you are, after all, anonymous.

10 Responses to “Algorithmic Trading, Promise and Perils”

  1. dead hobo says:

    Take look at a 1 1/2 year (more or less) chart for any major index. Actually, look at several. Tell me if you don’t see the rightmost point of the right shoulder in a head and shoulder formation. Then, consider the economic environment and ask yourself if the picture fits the environment. Greece will make a nice catalyst for what I suspect will be a major event. QE can only do so much and if all you have is artificial liquidity, then you don’t have much substance.

  2. PeterR says:

    Great post, thanks Barry.

    I won’t keep posting quotes from HAL (2001: A Space Odyssey), but I wish more people realized just how weird and crazy this could get.

    In an instant!

    Have a good weekend.

  3. Frilton Miedman says:

    I trade indices much more than individual stocks for this reason, observing volume is almost meaningless now.

  4. KeithOK says:

    Tell me if you don’t see the rightmost point of the right shoulder in a head and shoulder formation.

    Actually, when I look at the chart, I see the rear 4/5ths of a stegasaurus, but I guess there is always some degree of subjectivity in technical analysis.

  5. wally says:

    I suppose if you regard ‘trading’ as a form of investing, this is bad news. But we shouldn’t be doing that anyway, right?

  6. pintelho says:

    Hi BR…I know you are a truth seeker and are always proud to show different persepctives in order to challenge our (and your) biases.

    Are there any pros to algorithm trading? besides the usual “it increases liquidity” bullcrap…I mean there is a lot of in depth views and analysis against algotrading and I am like you hating that it exhists.

    However, what is the reason it exhists at all? the efficiencies gained seem miniscule in scale compared to the flash crash losses that it opens the system up to…I mean the fact that an entire firm can be sunk with a fat finger or poorly written/tested line of code is clearly evidence against utilizing algos for whatever efficiency Knight Capital has gained over the years…it just lost it’s entire business to it.

    anyway anything for algo trading that is reasonably believeable would be a nice hting to read as well.

  7. inthewoods says:

    That article seem to think there were very sophisticated computer models going on at LTCM – but from the book “When Genius Failed”, it seems pretty clear that was an image/marketing, and most of what they were doing was just simple stuff in Excel. Am I remember incorrectly?

  8. dead hobo says:

    KeithOK Says:
    August 9th, 2012 at 1:28 pm

    Tell me if you don’t see the rightmost point of the right shoulder in a head and shoulder formation.

    Actually, when I look at the chart, I see the rear 4/5ths of a stegasaurus, but I guess there is always some degree of subjectivity in technical analysis.

    reply:
    ——–
    Try letting your eyes go a little out of focus, then think of England. I find that helpful. Actually, the head & shoulders is one of the few technical analysis techniques that has validity, if you put it into context with actual events and not just superstition beliefs about magic charts. It’s useless unless it matches up with historical events. This one demonstrates QE, LTRO,Draghi. Unless real economics drives the charts higher because the economy actually improves, say goodbye Gracie in a few weeks.

  9. blackjaquekerouac says:

    yet again we have the ridiculous claim of a”the algo did it.” really? “and who made the algo”? let me guess…a human. Knight was a failure of INTERNAL CONTROLS…not a problem with “a faulty algo.” and there is no greater control than to make sure “the human only has so much of a on button to hit.” there’s no way a trader…let alone a trading company…is going to let machines run their trading operation. the machines exist to CONTROL the humans…not the other way. since we will never get an investigation into how “the machines” do this exactly however…

  10. KeithOK says:

    Try letting your eyes go a little out of focus, then think of England. I find that helpful. Actually, the head & shoulders is one of the few technical analysis techniques that has validity, if you put it into context with actual events and not just superstition beliefs about magic chart

    I can’t argue with that. If a technique works consistently, I guess that’s all that matters. I’m probably a little bit too skeptical when it comes to technical analysis.