Listen carefully.

Listen carefully and you can hear the industry spinning the Knight algo situation not as a market structure problem but as a risk management issue.  Since the August 1st “Knightmare”, we have seen numerous industry insiders speaking out that risk needs to be better managed.  They have been advocating adding new Risk Officers and even adding more software to detect problems.  An August 22nd interview with the Direct Edge stock exchange CEO, Bill O’Brien, is a perfect example of what the industry has been spinning:

“Now that automation is such an essential part and change of pace is so dynamic, we really need to make sure the risk management and control systems are in place…Technology has permeated the stock market. We need to control that risk more effectively with any firm but we also have to be more constructive working together cooperatively…I think you are going to see a lot more focus and cooperation among exchange to control the incremental risks that technology has brought to the system and I feel pretty good about that.”

Well, we are glad to hear the exchange executives finally think it is time to work on risk management.  Considering that the stock market produces millions of messages per minute and trades in microseconds, this is probably a good idea.  But we say, what took you so long?  And is risk management really the issue or is that just something to deflect the regulators and the public from the real issue which is our fragmented market structure and the embedded conflicts of interests that exist in it?

We saw something very similar to this happen right after the Flash Crash.  Almost every industry insider was immediately advocating the same remedy: circuit breakers.  If we only had single stock circuit breakers, then the Flash Crash would have never happened, they said.  The SEC was convinced and spent the next two years applying small band aid fixes but neglecting to look at the bigger picture problems.  The industry insiders were successful and deflected the SEC two years ago from the real issues and they are trying the same stunt right now.

And it appears to be working again. The SEC has latched onto the bait and will be holding a market technology roundtable on September 14.  Here is what their press release signals about the roundtable:

While the SEC recognizes the central role that technology plays in different aspects of our market structure, the agenda set forth below is intended to focus on how appropriate controls or processes for the implementation of technology can support a robust and reliable market.”

The participants have yet to be announced but we expect the same folks that we always see at these events to show up.  They will claim that they have better risk management controls and that they are going to work together to make sure that another Knight algo situation never happens again.

If the SEC was really serious about reform, they would be looking at bigger picture items like the elimination of the maker taker model.  They would dust off their 3 year old dark pool regulation proposal.  They would look at the exchange data feeds and eliminate the excessive information in them that is hurting institutional investors.  They would stop approving conflicting order types.

We hope the September 14 roundtable produces some concrete action steps but unfortunately we have seen this movie before and pretty much know how it ends.

-Sal Arnuk & Joe Saluzzi,  August, 2012


Joseph Saluzzi ( and Sal L. Arnuk ( are co-heads of the equity trading desk at Themis Trading LLC (, an independent, no conflict agency brokerage firm specializing in trading listed and OTC equities for institutions. Prior to founding Themis, Sal and Joe worked for more than 10 years at Instinet Corporation, pioneers in the field of electronic trading, and at Morgan Stanley.


Category: Really, really bad calls, Regulation, 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.

8 Responses to “Listen Carefully”

  1. NoKidding says:

    I’d like a 1-minute order-to-execution delay plus 1 minute minimum holding period. In theory a Commidore 64 with dialup could then compete with liquid cooled servers on the exhange floor.

    The trouble with all hobby sports is that somebody can buy the game. Arbitrary solutions like the one I proposed usually crush innovation and take the fun out of it.

    So whats more important for a game nobody is required to play, fair or fun? Football tried fair and baseball tried fun. Neither really worked.

  2. A says:

    Remember: this is the same SEC that basically ignored Bernie Madoff.
    Once again, we have to ask the question: who is really in control ?

  3. Frilton Miedman says:

    They didn’t just ignore Madoff, he was a member of the SEC, enabling him to write the “Madoff exemption” that allowed him to get away with it.

    Saluzzi, as always, is correct – the SEC is useless as long as we don’t regulate revolving doors and personal conflicts.

  4. ottnott says:

    “Risk management” as currently practiced appears to be relevant only in low-risk conditions.

    Keep it simple: manage leverage.

  5. drtomaso says:

    I am not sure that this was exactly the type of risk management the quote offered was referring to- there is a discipline of IT that is also called “risk management”- and that seems very pertinent from what I know about the Knight situation. This was a software f-up: they released something without the testing environment being exactly configured like their production environment, and learned the hard way that the configurations were not the same. Thus whatever testing they did before going live was meaningless.

    And yes, as the markets become more and more computer driven, proper software development risk management practices are fundamental. That means testing standards, data governance standards, proper QA procedures, and funding for IT groups that are considered second-class citizens in much of the finance space.

  6. philipat says:

    If there ever is any serious discussion regarding the impacy of HFT, which will only ever happen when the cirdle jerk which the Equity markets have become results in no more money to scam from other than competing algos, the data from Nanex will be most valuable in confirming all the worst (K)nightmares?

  7. vachon says:

    Reality check? Never happen. None of them can afford to deflate the balloon because none of them can afford the margin calls.

  8. AnnaLee says:

    Processes make good Powerpoint. Nothing better than risk management. Note minimization of risk isn’t the same thing as solving HFT disasters. I think the SEC is adapting DOD methods.