Technology glitch – Another black eye for equity markets

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Traders work at the Knight Capital kiosk on the floor of the New York Stock Exchange. Knight Capital Group Inc said on 1 August, 2012, that a “technology glitch” in its market-making unit had affected the routing of shares of around 150 stocks to the New York Stock Exchange, where abnormal volatility roiled the markets in early trading. Photo – Reuters

Algorithms and quantum physics. These two things seem to be more ingrained in science and mathematics more often than finance but thanks to the new innovative in computer technology and trading these have become the new pass and part of the finance industry. With phenomenon like spread trading and high frequency trading, trading and brokerage houses are using every advantage possible they can to eek out the smallest of gains over their competitors in the cut throat world of equity trading.

In line with this progress, the problem caused on Wednesday in the systems of Knight Trading should not then come as a shock but as a technological glitch, which are normal and occur everywhere in the world. What makes them a cause of concern is the fact that due to one glitch, people are liable to lose money that they have invested in the stock market and they are the people who end up paying for someone else’s mistake.

Knight Capital Group Inc, who is a market maker for the New York Stock Exchange, saw heavy computer trading in the early hours of trading on Tuesday which overwhelmed the systems. This comes in the long line of equity scandals after the failed Facebook IPO which is still reeling its havoc on the markets and the flash crash of 2010 where again a glitch caused the market to lose $1 trillion in minutes. The short term losses are still being evaluated in the aftermath, however, the long run impact to market sustainability and investor confidence is clear. It seems first the structured product market, then the derivatives market and now the most robust equity market is going through a tough time in terms of market image.

There are calls of more accountability like there was in the early 1990s where traders and companies saw tougher punishments. Analysts say if tougher punishments were in place, then recent incidents like the Facebook IPO debacle and now Knight Capital’s glitch wouldn’t have taken place or would have been rectified earlier.

The key fallout that would be seen in the market is that Knight Capital would be held responsible for the losses and would have to reimburse the clients and investors in whatever possible ways. Early estimates show a loss of $170 million. The share price of the company also took a hit falling nearly 33% in yesterday’s trading with today’s impact yet to be seen. Knight Capital would also be held responsible for bringing its systems up to the level expected which could mean a probation period until exchange officials are satisfied with it. They would also have to sustain confidence in its market making capabilities which have been affected as well.

Experts are now calling for more oversight and monitoring of algorithms and computer based trades which have gone unnoticed or have been barely checked till now. The checks and balances become more vital when the amount of money involved is added to the equation. In such a sensitive environment right now, everything should be done to ease the apprehension of the market and correct the system before another major crisis takes place. There is a pattern in the older crisis where all market participants do not keep a vigilant check of the systems before there is a total meltdown. In accordance with that, action should be taken to avoid any repeat of the situation in the future.

Zain Naeem is the head of equity research at Maan Securities (Pvt) Ltd. He is a Lahore-based commentator with more than 3 years of experience in trading and research at the Karachi Stock Exchange and Lahore Stock Exchange. He enjoys writing and commenting on the finance front and presenting it to various audiences in different forums. Zain is deeply interested in politics, business and finance and is fascinated at how the three intermingle with each other.

The views expressed in this article are the author’s own and do not necessarily reflect Arabian Gazette’s editorial policy.

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