financial terrorism -feedback loop destruction

Here is a portion of text from todays 'Daily Reckoning', which perhaps should be read by everyone, especially the staff at the ASX and ASIC, and by government ministers and regulators.

As you will understand, the potential to cause 'Financial and Economic Terrorism' through the use of Algorithmic Trading is massive.

--Your editor's phone began buzzing this morning shortly before 6am with texts asking us to turn on CNBC. There we saw what you saw: the Dow Jones had its largest-ever intra-day decline since 1987. The index fell nearly 1,000 points and almost ten percent as about $1 trillion in market value briefly got wiped out.

--By the end of the day the loss was just under 347 points or 3.2%. And CNBC was reporting that the whole affair was trigged by a trader entering the wrong number on a trade, probably in Procter & Gamble stock, which fell nearly 37% at one point. CNBC said that, "The erroneous trade may have involved E-Mini contracts - stock market index futures contracts that trade on the Chicago Mercantile Exchange's Globex trading platform. The composition of the E-Mini is similar to the stocks in the S&P 500."

--So maybe it was all just a misunderstanding. But it was a costly one. When computers take over decision making for human beings via program trading, then the catalyst for a given event can be erroneous and still have real world consequences. Program traders use algorithms that trade automatically buy and sell the market based on resistance and support levels determined by models.

--Program trading accounted for about 24% of the trading volume every day for the most recent week for which data were kept, according to the NYSE. During the last week in April, that meant nearly 700 million shares a day were trading hands based on algorithms. It's not hard to see what happened last night.

--A featherless biped made a keystroke error on a P&G trade and erased $60 billion from the company's market cap. The decline in P&G triggered automated sell orders which drove the Dow below 10,000. The very crossing of the Dow below 10,000 most likely triggered a flurry of buy orders. Voila! Chaos!

--Well, not chaos. But certainly volatility. And you thought stock prices were determined buy buyers and sellers with live brains deciding the discounted current value of future earnings. Nope.

--To us, the big takeaway from yesterday's US episode is how, in the rush to digest and reprice news and information constantly, the market now appears susceptible to runaway feedback loops that swing prices and trigger buy and sell decisions automatically. This does not seem like an improvement in efficiency. It seems like a systemic vulnerability that could be exploited in the future deliberately to cause mass panic and wealth destruction.

--Expect an investigation, although don't expect anything to change...until next time.

Gw

There are two things I know of that are infinite; the universe, and human stupidity. And I am not sure about the universe.
(Albert Einstein)