Flood of Errant Trades Is a Black Eye for Wall Street By NATHANIEL POPPER
An automated stock trading program suddenly flooded the market with millions of trades Wednesday morning, spreading turmoil across Wall Street and drawing renewed attention to the fragility and instability of the nation’s stock markets.
While the broad stock indexes quickly recovered and ended the day slightly down, it was the latest black eye for the financial markets. The runaway trading suggests that regulators have not been able to keep up with electronic programs that increasingly dominate the supercharged market and have helped undermine investor confidence in stocks.
Traders on Wednesday said that a rogue algorithm repeatedly bought and sold millions of shares of companies like RadioShack, Best Buy, Bank of America and American Airlines, sending trading volume surging. While the trading firm involved blamed a “technology issue,” the company and regulators were still trying to understand what went wrong.
The debacle comes after the botched Facebook initial public offering on the Nasdaq exchange in May and the aborted effort in March by another exchange, BATS Global Markets, to bring its own stock public. The episodes, along with the flash crash of 2010 when the market lost trillions of dollars of value in minutes, have stoked suspicions that stocks are safe only for specialists, and sometimes not even for them.
“The machines have taken over, right?” said Patrick Healy, the chief executive of the Issuer Advisory Group, a capital markets consulting firm. “When events like this happen they just reaffirm that these aren’t investors, these are traders.”
The errant trades began hitting exchanges almost as soon as the opening bell rang and came from a single New Jersey broker that specializes in computer-driven trading, the Knight Capital Group. Shares of more than 100 companies, including big names like Alcoa, Citigroup and Ford suddenly spiked up or down. The New York Stock Exchange had most of the mistaken orders, but all of the nation’s exchanges executed trades for Knight and all agreed to cancel the trading in six stocks that had especially extreme movements.
One of the six, Wizzard Software, saw twice as many shares traded in the first half-hour as there were during all of Tuesday, artificially catapulting its stock more than 300 percent, according to the data firm Nanex.
The trades placed by Knight may have left the firm with millions of shares of overpriced stocks that quickly lost their value after the chaos ended, but the company did not comment on its potential losses. The firm’s own shares ended the day down 32 percent amid concerns about disgruntled customers and lawsuits.
Knight is one of many companies whose fortunes have risen as regulators made a series of changes over the last 15 years that have opened up the markets to new exchanges and trading firms that use computer programs, or algorithms, to execute thousands of trades a second. High-speed firms use the algorithms to make money from small changes in stock prices and now account for more than half of all stock trading.
But the changes have also introduced instability into the system, which was made clear in the flash crash. After that event, the Securities and Exchange Commission set out to add safety valves to the system. But the turbulence on Wednesday reinforced the belief that regulators had not been able to keep up with the growing sophistication and speed of the market they were overseeing.
“You think there is somebody watching the control panel somewhere,” said Larry Tabb, head of the Tabb Group, a market research firm. “We still don’t have a firm grasp over our market infrastructure.”
The most important change that the S.E.C. made after the flash crash was to introduce circuit breakers that are supposed to halt trading if a stock’s price makes extreme movements. The circuit breakers, though, do not start working until 15 minutes after trading opens, so they could not catch swings that happened in the first minutes of trading Wednesday.
In addition, the circuit breakers are programmed to respond to changes in the price of shares, not changes in the number of shares being traded, so they did not stop much of the unusual trading.
In the end, trading was halted in five stocks: Molycorp, Corelogic, Kronos Worldwide, China Cord Blood and Trinity Industries.
The S.E.C. also made plans after the flash crash to create a system that would track all stock orders in real time as they were placed. Last month, though, the agency said it had modified its plan and would gather the data only a day after trades were placed.
“Things can get out of hand very quickly and there is nobody who can immediately do anything about it,” said Eric Hunsader, the founder of Nanex.
On trading desks across Wall Street, the turbulence on Wednesday was apparent as soon as the markets opened, particularly because trading is usually down during the summer months and has been especially light this summer because of all the recent blows to investor confidence.
“We were surprised to see that amount of volume so early in the session, given how much volumes have continued to decline,” said Ryan Larson, the head stock trader at RBC Global Asset Management.
Knight later said that “a technology issue occurred” in the division of the company that uses computer algorithms to buy and sell stocks from other market participants.
Soon after the chaos ended at 10:15 a.m., the industry’s self-regulator, the Financial Industry Regulatory Authority, convened a call with all of the major exchanges that lasted for the rest of the trading day and centered on the stocks that had been hit and where the trades had been executed, according to employees at the exchanges. The S.E.C. had a separate call with Knight and the New York Stock Exchange, according to people briefed on the call.
Even before Wednesday, the stock industry was torn by feuds as regulators examined recent technical errors and broader structural cracks in the markets.
Knight, for instance, recently criticized Nasdaq for the technology flaws that the exchange suffered during the Facebook initial public offering in May. Knight has said it lost $35 million because of Nasdaq errors that delayed trading and has threatened to take legal action. Another broker, UBS, said this week that it had lost more than $350 million during the public offering.
On Wednesday, Nasdaq employees on the phone call with other exchanges, demanded that Knight provide a full accounting of its own technology problems, according to someone on the call. Analysts said that Knight could face lawsuits for the mistaken trades.
Wednesday was also the day that the exchange introduced a platform that segregated orders from retail investors to offer them better prices. The platform faced strident opposition from Knight and other market participants, which complained that the program would make markets less transparent, but regulators decided to allow it last month.
There was no immediate information from Knight or the exchange on whether the new platform played a role in the morning’s problems.
After the early surge in volume, trading settled down late in the morning and investors soon turned their attention to the Federal Reserve’s decision to defer action to support the flagging economy. The Standard & Poor’s 500-stock index closed down 0.29 percent at 1,375.32. The Nasdaq slipped 19.31 points, or 0.66 percent, to 2,920.21. The Dow Jones industrial average fell 37.62 points, or 0.29 percent, at 12,971.06.
The Treasury’s benchmark 10-year note fell 16/32, to 102 2/32, and the yield rose to 1.52 percent from 1.47 percent late Tuesday.
But many market watchers warned that the full effect of earlier market flaws had only been felt in the ensuing weeks and months as investors continued to transfer money out of stocks, discouraged by the mishaps.
“It may have a broader impact on Main Street, who looks at Wall Street and says it’s just another illustration that the markets are broken and the little guy doesn’t stand a chance,” said Matt Samelson, the founder of Woodbine Associates, a capital markets consulting firm.
Michael J. de la Merced and Ben Protess contributed reporting.
