The recent plunge in equity markets has placed high frequency trading platforms under fire from both regulators and political administrations on both sides of the Atlantic.
At one point last week, the Dow Jones industrial average dropped nearly 1000 points before rallying to a 348 point loss.
Initially, viewed as a fat finger error attributable to a single trade, the regulators along with the relevant exchanges and market participants have found no evidence of human error causing the plunge which wiped $1,000bn off the markets.
Looking back, fat finger errors have created significant issues for banks over time. In 1992, Salomon Brothers sold a flawed customer order and knocked 15 punts of the Dow Jones. In 2001 another leading tier 1 bank sold 610k Japanese securities at 16 yen instead of 16 shares at 610k yen.
Ten years ago where were fewer than 10 US equity exchanges. Today, there are more that 50 platforms providing greater competition along with tighter bid / ask spreads. A similar picture is painted across Europe where Mifid paved the way for a myriad of new exchanges to appear on the market.
In my experience, as an expert on trading technology across multiple asset types, the chance of a human error causing such a significant swing is highly unlikely given the systematic safeguards now in place to prevent large orders being submitted in error.
It’s my view that 2 key areas need to be addressed –
1. Holistic Regulation
The new innovative trading practices that are in use today including high frequency trading, dark pools and direct market access has exposed the regulators with a significant gap.
At a time when they are still reeling from the political fallout of the credit crisis, the technological and product innovation across the equity markets continues at warp speed.
The regulators need to look long and hard at how to close the gap and ensure that there is a single set of eyes across a fragmented market. Only by providing a truly holist approach to regulation, can the regulators guarantee greater market stability, transparency and efficiency.
2. Circuit Breaker
In addition, market participants along with the trading venues need to ensure that they don’t continuously feed in orders once markets go into terminal decline and liquidity dries up.
This has been seen before in 2008 and we can’t afford to continue to re-examine events once the horse has bolted when we know that there is an issue.
What I strongly believe is needed is for the market to adopt a circuit breaker approach. These circuit breakers would trip when liquidity disappears off the cliff as we saw in the markets last week
The major exchanges along the regulators and all market participants need to work hand in hand to re-establish market credibility.
First, the root cause of last week’s plunge needs to be accurately determined. Only then can all market participants and regulators work together to develop an effective circuit breaker to promote greater market stability, efficiency and transparency.
Email : ian@IanAlderton.com
Tel : +44 (0) 7702 777770