Trading in the Era of High-Speed Algorithms (Part II)

In light of the recent incident that rattled the S&P 500 and the Dow Jones Industrial Average that involved the Associated Press (AP), I decided to write a sequel to the previous post. I would like to highlight how algorithmic trading (algo trading) computers can exacerbating outcomes. Beyond the many obvious advantages of algo trading, trading platforms (and machines in general) might fail sometimes (duh, obviously!). Due to the high interconnectedness of trading platforms, such as the one used by the, the results can be devastating.

Tweet #1

Tweet #2

On April 23 2013, a false tweet (check tweet #1) by AP viraled out and rattled the S&P 500 index, where AP's stock is traded. On the outset, the whole incident can be attributed to cyber security but because we live in a ubiquitous and seamless digital environment, instantaneously, high-frequency traders jumped on and acted on the "false" tweet. The algorithms was triggered by unusual volatitlity that took place in a span of 2 minutes. The false news about the explosions in the white house created a panic in major stock markets in the United States. In this seemingly short amount of time (2 minutes), the S&P 500 lost $136 billion. Although the market had recovered its loses in the next 3 minutes, analysts think that many orderes might have gotten stuck or even that some foul play might have occurred.  Algo trading wasen't the cause of this ripple effect, but it made it worse by executing automatic major sellouts (orders that were previously placed in the systems).  One of the options that algo trading is famous for is called "stop-loss" in which the system will automatically start selling your stocks if the price falls below a certain pre-indicated level. As you would imagine,  after AP's tweet, programmed computers started executing thousands of stop loses in a short span of time. What is even more scary is that the algo machines acted on the news with very minimal (or even no) human supervision, at least not during those 2 minutes. 

                                                 AP Twitter Hack Highlights Vulnerability of Markets

According to the attached video from Bloomberg TV(via You Tube), Stephen Ehrlich of Lightspeed Financial says that the main problem with these algo trading machines was that they picked up the tweet feeds and acted on their own. This shows how vulnerable and frigle are these systems to any bogus information thrown at them. During this incident, thankfully it went by with minimal damage (or at least, this remains to be seen) but what would happen if things would go out of control and started causing irreversible damages!

This incident shows how interwoven and thin are social networks, their affect is felt even beyond their direct platforms due to over-connectivity and dissemination of information. This was a clear example of how powerful is the impact of ICT  on not just media and social networks but also on the behavior of programmed machines that is capable of bringing a whole financial industry to halt. Another issue is clearly cyber security which many high-frequency traders and hedge fund managers aren't big fans of because they thrive on the high-volatility in markets. Having tight security systems would restrict how algo trading operates and might weakens its whole purpose.  

-FM