Stock Exchanges At Risk From Rogue Trading Algorithms?

There was a short story in yesterday's Financial Times of London on the possibility of a rogue trading algorithm seizing up a stock exchange. Apparently, trading done by computers has exploded and there have been instances of a "rogue algo" causing problems, which is starting to make stock exchange owners  and regulators alike nervous.

For instance, about two weeks ago, Credit Suisse was fined $150,000 by NYSE Euronext, the group that runs the NY Stock Exchange, for failing to control its trading algorithm in late 2007. According to the NYSE,

"... on Nov. 14, 2007, beginning at approximately 3:40 p.m., a Credit Suisse proprietary algorithm routed hundreds of thousands of cancel/replace requests to the New York Stock Exchange for orders that had been previously generated by the algorithm, but, due to an unforeseen programming issue, were never sent by the algorithm.   The unusually large amount of cancel/replace messages contributed to the over-queuing of message traffic in all of the securities, approximately 975 in total, traded at five posts on the NYSE Trading Floor.  Messages, including new orders, modifications of orders, and cancellation requests were frozen in queue and could not be immediately processed.  These five posts could not be closed on time, ultimately closing between 4:10 p.m. and 4:27 p.m."

Furthermore, Credit Suisse, "... also failed to properly monitor the operation of the algorithm, as evidenced by the fact that the firm was unaware that hundreds of thousands of messages sent by the algorithm were being rejected by NYSE systems until being notified of the issue by NYSE Regulation the following day."

A NYSE spokesperson told the FT in an earlier story that it "had pursued the case partly to send a message to other trading firms."

Last November's London Stock Exchange problem is suspected of being caused by a similar incident, the FT said.

Yesterday's article FT states that nearly 60 percent of trading in equity markets is driven by computer algorithms, with the figure expected to climb even higher. Program trading volume in the NYSE currently runs about 25 - 35% of the New York Stock Exchange on a weekly basis as a comparison.

The US Securities and Exchange Commission approved rules in October of last year for breaking clearly erroneous trades, and has proposed new rule that would require brokers to establish procedures to prevent erroneous orders, the FT says.

However, the FT also states that "regulators say it is unclear who is monitoring traders to ensure they do not take undue risks with their algorithms."

I guess you just have to trust traders to do the right thing. That worked so well with bankers and their management of risk after all.

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