Yesterday's steep stock market plunge of 416 points sent a warning of how vulnerable the market structure is to systems glitches and data backlogs when there are unexpected volume surges and rapid sell-offs in an electronic trading environment.
As most of us know, problems began around 2 p.m. when the Dow Jones Industrial Average was already down 200 points -- in part a reaction to the sell-off in Chinese stocks, translated into concerns about the U.S. economy. I was in the car at 2:30 p.m. whenCBS Radio reported that the market was crashing and the Dow was down 250 points.The heavy sell-off in U.S. stocks caused a 70-minute lag in correctly calculating the value of the Dow Jones Industrial Average, according to Dow Jones Indexes, which issued a statement today.
In the release, Michael Petronella, president of Dow Jones Indexes, said the problem arose in the system responsible for feeding market data into the calculation system.
Recognizing the problem, Dow Jones Indexes switched to a back-up market data system for calculating the index, which immediately caused the index to drop by another 200 points at around 3 p.m. -- so the market was down over 500 points.
The switch over to the back-up systems caused all the prices to be processed at once, and this led to the downward spike in the reported index value, according to the release. When the Dow Jones index was adjusted to the true value and the market plummeted 200 points, this probably triggered algorithmic trading programs to generate buy and sell orders, which were concentrated in the Dow 30 stocks, rather than dispersed throughout the market, the source conjectures.
As reported in today's Wall Street Journal, the heavy volume reportedly overwhelmed the systems in the last hour of trading at the New York Stock Exchange, which recently switched over to the hybrid trading system. While a spokesman for the NYSE in the WSJ article said the hybrid trading system, which executes orders electronically and sends some orders to the floor, worked fine, the problem was with another system that feeds it that couldn't handle the overload of orders. (According to a source, an order routing mechanism within the NYSE's DOT sytem was the problem.) Some orders were not executed and others were sent to alternative execution venues - including NYSE Arca.
One brokerage source called me to say that brokers were experiencing delays in their network's routing orders to the NYSE and not receiving execution reports on time. There were also problems using Nasdaq to route orders to the NYSE or to alternative trading systems.
The broker is concerned over the systems snafus and what this means for the future given that Regulation NMS takes effect next Monday, March 5th. "In a day like today, after years of investing in technology and planning for two years, what's going to happen when Reg NMS is implemented?" asks the brokerage executive, whose firm provides algorithmic trading strategies to institutions. "I don't understand why we experienced the problems," he vented after the market close yesterday.
An article in the Financial Times also attributed the market decline to hedge funds and high-leveraged strategies. "Once the market turns they have to get out fast," said a trader quoted in the FT article.
If there is a capacity problem, this raises red flags since Reg NMS starts on Monday and all the new electronic trading systems go live. No one knows how these systems will interact with each other. The question is: Should we be worried? The industry is adopting more-aggressive electronic trading strategies and relying on a handful of vendors for their order routing. Should these vendors be regulated? What were your firm's experiences yesterday? Please write in. Ivy is Editor-at-Large for Advanced Trading and Wall Street & Technology. Ivy is responsible for writing in-depth feature articles, daily blogs and news articles with a focus on automated trading in the capital markets. As an industry expert, Ivy has reported on a myriad ... View Full Bio