Financial firms struck a deal to rescue Knight Capital Group after the firm sustained heavy losses from a flawed automated trading program last week, so does that mean it’s back to business as usual? Not necessarily. Banks and regulators are still struggling with risk management and how to police high speed, risky and complex trading strategies without harming liquidity.
One academic contends that speed trading is in dire need of more regulation or at least a few simple things like speed bumps or on-off ramps.
“There aren’t enough speed bumps and regulation to allow the financial markets to keep going when high speed trading glitches occur,” said Sharyn O’ Halloran, a professor at Columbia University at the School of International public affairs, on CNBC this morning. O’ Halloran, contends there aren’t enough signposts for algorithmic trading “to make sure that when glitches happen you can pull the plug, you can get over to the safety lane —that we do the things that are needed to make sure the markets continue to function.”
“How about a digital call box on the side of the road? We’re literally talking about that,” O’Halloran tells CNBC anchor Joe Kernen, who seemed skeptical about adding more regs at a time when volumes are thin and the impact of speed trading is more pronounced. “If investors were to come back,” asked Kernen, would the activity of speed traders matter less, implying there would there be less need for more regulation?
“When volumes are thin and illiquid that’s when you get these types of manipulations,” agreed O’ Halloran. While high speed arbitrage trading is normal to find a half a cent here and there to make money, O'Halloran suggested it was was more pronounced. “Electronic trading is a way to squeeze every dime you can out of these trades,” suggesting that it’s more pronounced “because it’s so hard to make money.”
However, some pundits are saying there’s too much “hyperventilating” going on about Knight’s technical glitch and that it’s not fair to blame electronic trading for investors pulling money out of the stock market. In the same interview, Andrew Ross Sorkin, editor at large of the New York Times/Dealbook, chimed in, arguing that electronic trading is not the reason that individual investors are leaving the stock market. Rather, it’s that “a whole generation of investors hasn’t made a buck.” Ross made similar points in his Dealbook column: “Why Investors Flee Equities? Hint: It’s not The Computers.” While admitting that technical misfires such as Knight’s algo, the Facebook IPO problem and BATS withdrawing its own IPO, are not exactly instilling investor confidence, Sorkin maintains that economic fundamentals and not computerized trading snafus are behind what’s prompted investors to pull $130 billion out of the stock market in the last year.
Sorkin claims that investors are not focused on the computer trading upheavals, though he admitted here is a crisis of confidence among investors who worry that the game is rigged against them due to things like insider trading.
To win back trust, the professor insisted that U.S. equity markets need more regulatory intervention. “We need to put in the things in the road, what you do to handle this, the internal and external roads.”
“That’s to me what’s important right now and it’s the job of the regulators to step in and do their job,” said O’ Halloran.
Despite the complexity of the markets, she offered some simple steps that market participants could follow to avoid the next blow up. “When you are writing a program you have a stop button. These things aren’t hard,” said O’Halloran, alluding to reports that Knight’s program lacked a kill switch. “And you can do testing, you actually have a three-month period in which to do parallel testing,” she added, perhaps not realizing that would never work on Wall Street, since the algos may only work for a few weeks. If they are tested for three months, they could be useless.
Still, her message is worth considering. “There’s many ways in which you beta-test software programs, so this was not well executed either on the regulator’s side or Knight’s side to oversee fundamental infrastructure.”
Click here to watch the CNBC video, Speed Trading Without a Seat Belt.