Knight Capital, the biggest stock trader, loses an impressive $440 million — all its capital and more — in 45 minutes. They may go broke, unless a white knight (bad pun) bails them out today or this weekend. That’s not the story, though that’s all the financial press seems to care about.
A “glitch” in new software was the official explanation. What’s that mean? Theories I heard calling around:
+ A client gave them a big buy order to fulfill gently over five days. Knight’s computer’s filled it in five minutes by bidding the requested stocks up and up and up. Some computers and people saw what was happening and sold them the shares they wanted at a nice, high price.
+ The new software was programmed to buy at the “ask” price and sell at the “bid” price. Selling low and buying high will do it every time. Sadly, Knight did not have a big fortune to start with. And they didn’t end up with a small fortune. They ended up insolvent, also called broke.
What’s it all mean for you and me?
It hammers another nail into the coffin of investor confidence. A string of glitches — from the flash crash, to the Facebook IPO, to now this — is adding fuel to the already $150+ billion dollars of small investor money that has left the market in the past couple of years.
Who trusts the market any longer? Figure 50% to 70% of daily trades are now done by machines programmed to make money in secret ways, including:
+ front running customers’ orders, i.e. seeing someone wants to buy 1,000 IBM and buying them first.
+ bidding against their own customers.
+ manipulating share prices so the machines make money, but the human investors don’t.
Do we really know what’s going on? Does anyone?
Probably not.
Secrecy is the byword.
Knight was interesting. They were the biggest stock exchange, i.e. trading platform, that you had never heard of.
Did their computers also trade for themselves? Yes. Is that a conflict if interest? Yes.
Did anyone care? Probably the regulators. But none of them have the smarts to understand what goes on inside the black boxes that run computerized stock trading platforms. It’s so crazy that one programmer told me that if he could move his machines 100 feet closer to the computers at the New York Stock Exchange, he would have a major advantage.
100 feet. Go figure.
If you are a client of the following firms (as I am), your trades were done at Knight and you probably got screwed — got less money for your sales and paid more money for your purchases. This chart is from this morning on CNBC.
Now you know why it costs so little to buy and sell stocks. They make it up elsewhere.
The BIG problem with these high-speed stock trading machines is their power. Another software “glitch” and bingo the market is down 25% and we’ve all lost a lot of money. Will it happen? Yes. Won’t it be reversed by the nice humans at the regulators and at the exchanges, like the NYSE and NASDAQ? Maybe? Will they catch all the screwups? No.
Look what happened with Facebook’s opening day. UBS had orders from its customers to buy Facebook shares. It pushed the “execute” button. It got no confirmation from NASDAQ that the trade had taken. It assumed something was wrong with the communications or the Internet or the lines or something. So it pushed the button again and again. But all the trades had been executed. Eventually NASADAQ confirmed them all. And then Facebook fell and UBS got left holding the a bag full of shares neither it nor its customers ordered and, worse, the stock was falling and falling.
But what UBS (and lots of others) didn’t know was that NASDAQ had losses limited to only $35 million. Some legal thing no one knew about. Everyone got screwed by NASDAQ’s limited liability. NASDAQs basic attitude seems to be “Tough.”
It’s a new dangerous world for owning equities. I don’t have any simple answers.
Harry Newton who wonders why he didn’t short Knight when the first signs of its cockroachedness started appearing several days ago. Idiot me.
What a great day to be long in the market! What a great Friday to be an American, and not an Aussie who does not understand American can do spirit who talks about shorting our market. Shorting the market is no different than burning the American flag. It's just wrong and unpatriotic.
I'm so happy that I'm fully invested in this market that went up 2 percent on Friday. God bless this great nation, where with a little thought and a study of investing (Harry – wise up and finally read Ben Graham's “The Intelligent Investor”) one can become wealthy or wealthier.
America is the land of the free and home of the brave. Australia is an outback country full of wild dingoes and, based on this blog, people who don't know much about finance. I know where I'm proud to be from.
Newby,
It is a little known fact that Australia is the ONLY country to have fought with the USA in every major conflict side by side since our independence in 1901. We have been your staunchest ally through thick and thin, and will continue be so, because we love your country and your people. If you have a problem with Harry's investment strategies don't use this to belittle your most loyal friends. Besides, Harry is a naturalized American, making him as USA as you. Maybe you should visit our shores one day, you will see just how much we value our relationship with you guys, 99% of you are great people, shame on you.
Bernie
There are two ways to solve this problem:
1) Make all orders stand for two full seconds and for every order outstanding you must have cash margin to clear the trade if you are executed.
or another approach:
2) Return to open outcry markets. Orders can be entered and routed to the
floor electronically, but must be executed by actual humans.
Nathaniel Borenstein wrote in Programming as if People Mattered: Friendly Programs, Software Engineering and Other Noble Delusions (Princeton University Press, NJ, 1991):<i> “The most likely way for the world to be destroyed, most experts agree, is by accident. That's where we come in. We're computer professionals. We cause accidents.”
Harry, How do you know if the computers at Knight were not hacked or inflected with virus? The hackers would do everyone a big favor if they can cripple those high-speed black boxes so that our little investors who can only be best with an Intel i7 cpu could have an even playground … hope this is the Stuxnet for the black boxes …
We don't know is the simple answer. Knight did say that its new software was the problem. Were they telling the truth? Who knows?