In August only this year a US Investment Bank made global headlines reporting that a computer software glitch caused a malfunction in its trading system resulting in a trading loss of $440 million in just under an hour before the malfunction was noticed and the computer was switched off.

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The terminology is called “High Frequency Trading” or “Algorithm Trading” and consists of highly sophisticated computers using complex mathematical models to automatically trade on the financial markets. These computers are used to sniff out and exploit temporary price disparities and primarily used in arbitrage and short term trends in the markets.

“Algorithmic trading, sometimes referred to as “high-frequency trading,” is basically a computer program designed to set trades, which can be based on pricing, timing, quantity of an order or a combination of the former. In essence, the computer is doing trades without human input”.

“…They can move millions of shares around in minutes, earning a tenth of a penny off each share”. 



What makes interesting reading is that these “Computers” are responsible for almost 50% of trades executed on the European Market and a massive 70% in the US all done with little or no human intervention. Whilst Hedge Funds and Investment banks battle it out trying to produce an even faster trading platform to its rivals with more complex mathematical modeling, it is also raising concern with the financial regulators that this could all head for disaster.

The terminology “Flash Crash” came to prominence in May 2010 when the Dow Jones Industrial Index plunged almost 10% and went into a tail-spin only to recover a few minutes later. The reason for the sudden plunge can be blamed on High Frequency Trading computers and a technical glitch that sparked wild swings in share prices.

To bring this blog into a clearer perspective even today (Friday 5th October) the Financial Times reported the Indian Stock market suffered a “flash crash” wiping almost $60 billion off the stock market before making a recovery.

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At a time with already so much financial insecurity regulators are now stepping up their scrutiny of new trading technology and its impact on market stability.

Further Reading:

http://www.ft.com/cms/s/0/9869b272-0ecd-11e2-9343-00144feabdc0.html#axzz28LVhhPsV

http://www.telegraph.co.uk/finance/newsbysector/banksandfinance/9475292/Knight-Capitals-440m-trading-loss-caused-by-disused-software.html#

http://en.wikipedia.org/wiki/High-frequency_trading
Vincent Carbonare