Knight Capital loses $440 million in 45 minutes due to computerized trading

[Lemur866]

Well, this is big news:

http://dealbook.nytimes.com/2012/08/...40-million/?hp

Will the big Wall Street traders finally decide they need the SEC to ban or radically slow computerized trading? Should we we have a transaction tax on trading rein in the worst excesses?

Seems to me losses like this are equivalent to the famous "Black Swan" reverse-lottery trading. Bet huge amounts of money on statistically sure things, and reap small rewards. Except when something unforseen happens, like a tiny software error, and then you've lost huge amounts. But traders are addicted to this thinking because, hey, that unusual thing doesn't usually happen, and so you rack up your profits day after day and month after month and quarter after quarter. Then smash. In other words, professional Wall Street traders are, like most people, incredibly bad at risk management.

[Der Trihs]

Part of the problem appears to have been that no one was paying attention to the thing; apparently many traders noticed something was wrong pretty early on, but it was left to run on and on.

2) Why did it take so long to shut the damn errant program off? It ran for almost 30 minutes! Traders on the floor noticed a problem within the first couple minutes of the open — I was standing there — but it appears to have kept running to almost 10 a.m. ET.

Huh? Traders seemed baffled that it kept running, but when I asked a couple guys, "Why don't they just call up the source of the trade and tell them to hit the kill switch?" nobody had an answer.

[robert_columbia]

I accidentally the whole pension plan.

[Chimera]

Given the state of some phone systems and the damned voice operated systems, who is to say they didn't call them up and couldn't get through the system to a real person?

(and yeah, I'm mostly joking)

"IF OUR PROGRAM IS CRASHING YOUR STOCK PRICE, PRESS 1"

[YogSosoth]

Wall Street lost billions in the past few years and they had the audacity to fight against changes and regulation. These people live in the Wild West, where there are no rules. $440 million of other people's money is nothing to them, I'm sure the CEO will still walk off with a healthy golden parachute.

[Lemur866]

Except this wasn't $440 million they were managing for other people, this was half a billion of Knight Capital's own money.

[Joey P]

Originally Posted by Chimera

Given the state of some phone systems and the damned voice operated systems, who is to say they didn't call them up and couldn't get through the system to a real person?

(and yeah, I'm mostly joking)

"IF OUR PROGRAM IS CRASHING YOUR STOCK PRICE, PRESS 1"

do do do do do DO do do do The girl from Ipanema goes walking....

[Farmer Jane]

Why is this the CEO's fault?

[John Mace]

Originally Posted by Lemur866

Will the big Wall Street traders finally decide they need the SEC to ban or radically slow computerized trading?

Am I missing something when this looks like a question as to whether they will be asking to be saved form themselves? Why not just ban it themselves?

Should we we have a transaction tax on trading rein in the worst excesses?

What problem did this trade create for me or you?

[Chimera]

Originally Posted by Farmer Jane

Why is this the CEO's fault?

Ultimately he made the decisions that put this in place.

If he's going to claim the megabucks for how well the company does, then he needs to take responsibility for the failures as well.

[Voyager]

Originally Posted by Farmer Jane

Why is this the CEO's fault?

At sea the captain goes down with his ship.
On Wall Street the captain rifles the purser's safe, grabs all the alcohol, and jumps into his own private lifeboat saying "so long, suckers!"

Perhaps they saved money on programming staff, and couldn't afford to code all the safeguards they really needed. The bottom line is the bottom line, after all.

[treis]

Originally Posted by John Mace

What problem did this trade create for me or you?

The problem is that we don't know any answer to this question. We have seen that the market can drop 10% within 10 minutes and a trader can lose 440 million in 45 minutes. What else is out there? Are we sitting on some potential time bomb where some HFT causes things to crash artificially and then based on margin calls or some other linkage we have a real crash? No one knows for certain.

[Stratocaster]

Originally Posted by treis

What else is out there? Are we sitting on some potential time bomb where some HFT causes things to crash artificially and then based on margin calls or some other linkage we have a real crash? No one knows for certain.

Some effect we don't know about might trigger some other linkage we can't really describe? Maybe there's some even worse thing, worse than the first thing you mentioned that we don't know about. You're right, we just can't be certain. That's good enough for me, let's dismantle Wall Street.

[Chimera]

Tear Down The Wall!!!

[davidm]

Originally Posted by Stratocaster

Some effect we don't know about might trigger some other linkage we can't really describe? Maybe there's some even worse thing, worse than the first thing you mentioned that we don't know about. You're right, we just can't be certain. That's good enough for me, let's dismantle Wall Street.

No one is talking about dismantling Wall Street.

The problem is rapid automated trading. Things happen so fast that, if something does go wrong, there's a very real possibility of things getting disastrously out of hand before anyone even realizes what's happening.

There's no time for humans to do sanity checks on what's going on.

[Farmer Jane]

Originally Posted by Voyager

At sea the captain goes down with his ship.
On Wall Street the captain rifles the purser's safe, grabs all the alcohol, and jumps into his own private lifeboat saying "so long, suckers!"

Perhaps they saved money on programming staff, and couldn't afford to code all the safeguards they really needed. The bottom line is the bottom line, after all.

I'm not saying he won't fall for it. I just don't feel angry that he'll get a nice check with his departure. The company can't function without computerized trading and I don't see how it was his actual fault.

[Lemur866]

Originally Posted by Stratocaster

Some effect we don't know about might trigger some other linkage we can't really describe? Maybe there's some even worse thing, worse than the first thing you mentioned that we don't know about. You're right, we just can't be certain. That's good enough for me, let's dismantle Wall Street.

How about instead of dismantling Wall Street we limit computerized trading to trade once every minute instead of second by second?

On the other hand, to go back to the tempo of trade we had before computerized trading will destroy Capitalism and send us back to the socialism of the Reagan era.

[Stratocaster]

Originally Posted by Lemur866

How about instead of dismantling Wall Street we limit computerized trading to trade once every minute instead of second by second?

That still doesn't answer the question: Why? Or, as John posed it, what problem did this trade create for me or you?

[China Guy]

Originally Posted by John Mace

What problem did this trade create for me or you?

John, it interfered with the open and transparent trading of the market. You might complain about this but stock markets are a zero sum game. One person makes money on a stock, someone else loses. Just think if you bought some stock when all this was going on, and you bought a stock that had just risen 10% at the peak, and then it dropped back 20% to the "market price."

It's really not any different than the practice of front running. Which is to place a buy or sell order just ahead of a big order that you know is coming. You make a quick gain and no one is hurt. Except it hurts the efficiency of the market and games the system and people get hurt (or make windfalls) that shouldn't happen.

And in a bad case, it could cause bankruptcy or taxpayer intervention....

[TriPolar]

The volume of these transactions is so great that it can take much longer than 45 minutes to determine there is a problem. Accurate information can take 12 hours or more. There are millions of transactions each day, 24 hours a day, around the world. The cumulative balance of these transactions is only guestimated in real time.

[friedo]

Originally Posted by China Guy

John, it interfered with the open and transparent trading of the market. You might complain about this but stock markets are a zero sum game.

This is incorrect. Are you thinking about currency markets?

[septimus]

Originally Posted by Stratocaster

That still doesn't answer the question: Why? Or, as John posed it, what problem did this trade create for me or you?

There were murders a week ago in Colorado. What problems did those create for you or me?

Oh, wait a minute. When you wrote "me or you" you really meant "any innocent victim." How about, just for starters, those who bought at 29% above the opening (only 30%-higher trades were unwound). Or those who made a clever buy decision but got it unwound because it was off by 30%. Or, if the damage were a bit bigger, the creditors and customers of Knight Capital.

In a recent thread I read that Bill Gates, with his $69 billion, contributed exactly $69 billion of value to the World, no more no less. I tried to refute this via reductio ad absurdem but was accused of ignorance because I made it too absurd.

Someone won the $450 million Knight lost. Did they contribute exactly $450 million of value to the world?

[Rune]

Also in the news: other people earned $440 million in 45 minutes due to computerized trading.

[Stratocaster]

Originally Posted by China Guy

You might complain about this but stock markets are a zero sum game. One person makes money on a stock, someone else loses

Yes, in this instance, Knight Capital.

Just think if you bought some stock when all this was going on, and you bought a stock that had just risen 10% at the peak, and then it dropped back 20% to the "market price.

If I'm speculating, hoping to make a quick buck on the wave of an unexplained spike in the course of an hour, I shouldn't bitch when the results don't go the way I'd hoped. Anyone who lost in the first hour of the market, based on Knight's action, was not a long-term investor. It was a speculator who rolled the dice and lost.

This was not some firm gaming the system. It was a firm who had crappy controls who paid the price for it. Such is the market, which punishes bad decisions and systems of trading. I still don't see something that needs fixing here. Knight is paying for its poor processes, as it should.

[jackdavinci]

I thought for sure this was going to be about when Bane raided Wall Street in the latest Batman movie.

[John Mace]

Originally Posted by septimus

Oh, wait a minute. When you wrote "me or you" you really meant "any innocent victim." How about, just for starters, those who bought at 29% above the opening (only 30%-higher trades were unwound). Or those who made a clever buy decision but got it unwound because it was off by 30%. Or, if the damage were a bit bigger, the creditors and customers of Knight Capital.

I don't think of stock speculators as "innocent victims". YMMV.

[septimus]

Originally Posted by John Mace

I don't think of stock speculators as "innocent victims". YMMV.

The counter-parties to Knight's trades were, in some cases, ordinary retail investors. There are tags one can put on an order (Fill or Kill, All or None, etc.) but Trade Only With Fellow Speculator isn't one of them.

Retail investors wouldn't have overpaid by 29% if they used limit orders, but a previous thread covered reasons not to limit; and there are others.

[Voyager]

Originally Posted by Farmer Jane

I'm not saying he won't fall for it. I just don't feel angry that he'll get a nice check with his departure. The company can't function without computerized trading and I don't see how it was his actual fault.

Here is a story about it from the Register written by someone with a clue - except he got bid and ask reversed.
This was supposed to be a test - but somehow it went live.
Now, I don't expect a CEO to understand anything about software, but if your company lives and dies on computerized training I do expect him to tell the people who do to enforce some quality and internal testing requirements.

In the Times today I read that there was a new capability or type of trading launched, and Knights wanted to be first, ahead of more cautious competitors. If that is correct, and they were shooting for a deadline, then I wouldn't be surprised if they skimped on internal testing to meet it. The problem described in the Register should have been easily caught, but testing takes time and a good test environment costs money.
CEOs get a fortune because they are supposed to be so much better than lackeys like us. But when they screw up they get another fortune. Ancient kings and emperors who took the throne got the palace and the gold and the serving wenches - but when they screwed up their heads went on a pike. When they lost the big battle they didn't get to depart with half the gold. If we stuck the heads of failing CEOs on a financial pike maybe they'd try a little harder.

[Trom]

I'm glad the SEC made the right move for once and didn't cancel most of Knight's trades. That would have damaged the integrity of the equity market more than Knight's Algo Gone Wild.

[Enkel]

Originally Posted by Trom

I'm glad the SEC made the right move for once and didn't cancel most of Knight's trades. That would have damaged the integrity of the equity market more than Knight's Algo Gone Wild.

I agree. This is why they make errors and omissions insurance. Let them handle their own problems. If anything, they should get a fine for turning an untested application loose on the market and causing "false" market activity.

It will be interesting to see who claims harm once the list of the traded stocks are released. This was basically an automated reverse pump and dump. There has to be some third parties who were adversely affected.

The funniest part is that somewhere, there is a programmer going "Oh, crap!" and it's probably among the top 100 programmer 'Oh Craps!" out there.

[justrob]

Just curious, if the settings had been switched and they ended up making $440M in 45 minutes would they have had to return profits from prices that were more than 30% outside the normal trading range for the stocks?

[Lemur866]

If the settings had been switched they wouldn't have made anything, because nobody would have sold at the price they were bidding for and no one would have bought at the price they asking for. But because their ask price was below their bid price, they bought from everyone and sold to everyone and lost money on each transaction.

[justrob]

Originally Posted by Lemur866

If the settings had been switched they wouldn't have made anything, because nobody would have sold at the price they were bidding for and no one would have bought at the price they asking for. But because their ask price was below their bid price, they bought from everyone and sold to everyone and lost money on each transaction.

Sure, I get that, but that wasn't what I asked.

They screwed up and lost several hundred tons of money and, while not getting everything back, are getting a fairly large re-do. I'm asking if the screwup had reversed (which wouldn't have happened because no one else could have screwed up) would they be getting the same re-do?

[Nars Glinley]

Originally Posted by Der Trihs

Part of the problem appears to have been that no one was paying attention to the thing; apparently many traders noticed something was wrong pretty early on, but it was left to run on and on.

Bolding mine.

Probably because someone was making $440 million.

[septimus]

It seems interesting that these losses, in the space of minutes, were a significant fraction of the Baring's Bank losses 17 years ago, yet attracted much less attention. And there are doubtless many big financial rolls-of-the-dice that pass unnoticed.

I do hope I won't be accused of Soviet-style central planning, or coddling the ignorant by forcing them to wear seatbelts, when I point out that a very tiny transaction tax would curb some of the excesses on Wall Street (as well as raising enough revenue to lower somewhat the tax hike on Job Creators that the hateful crypto-Kentans are proposing). (I mention a 0.05% tax twice before, and each time someone responds with a link showing poor results from a 0.5% tax. Can we get one of our math experts to comment on the relative sizes of 0.05% and 0.5% ?)

Originally Posted by justrob

I'm asking if the screwup had reversed (which wouldn't have happened because no one else could have screwed up) would they be getting the same re-do?

It would be fun to construct such a hypothetical and expose a "double standard" but I don't know how you can. Accidents are bad -- it's almost like a law of thermodynamics. In the event, normal traders were happy to take easy profits. In your hypothetical, they'd have to be happy to take easy losses.

There is one way that might happen: If the other computer algorithms had an hitherto-undiscovered flaw that caused them to happily lose in some scenario and Knight's new algorithm, accidentally or not, exploited that.

[Trom]

How would a tax prevent software problems?

[septimus]

Originally Posted by Trom

How would a tax prevent software problems?

Did someone claim it would?

[Trom]

Originally Posted by septimus

Did someone claim it would?

I interpreted you bringing it up as it being a possible solution to the issue at Knight. If not, then nevermind.

[Enderw24]

I told Knight Capital to not invest so heavily in orange juice futures.

[Kobal2]

Well, I guess it's true what they say - to err is human, but you need a computer to really cock things up.

[ralph124c]

I wonder if some of Knight's execs secretly bet against their own firm? It has happened before.

[Voyager]

Here is an update from the Reg, with a plausible explanation of what went wrong with some links. It seems that they had a new trading program, and had a testing program to exercise it. The testing program had accidentally included in a package that hooked up to the actual exchange, and then merrily started to make trades - trades it thought were fictitious, but which were real.

The link points out that Knights is a market maker which does trades for others, and not a company which is doing risky investing.

Just a cock-up, which got big because the trading is so fast.

[BigT]

It's still a cockup that shouldn't be able to happen.

And I really, really don't get Sam Stone's attitude. Large falls in the stock market, because you don't feel an immediate effect, doesn't hurt anyone? You can't see any reason why the thing that caused the Depression should have safeguards to prevent a dumb computer from destroying it all?

You may choose to continue to take it for granted that these people know what they are doing, but they very clearly proved they don't. This sort of thing shouldn't have been possible--I'm barely a programmer and I could put in safeguards that would prevent this.

[Kobal2]

Originally Posted by BigT

This sort of thing shouldn't have been possible--I'm barely a programmer and I could put in safeguards that would prevent this.

No you couldn't. You could design 5 successive "If you do this it will fuck things up something ridiculous. Do you REALLY want to do this ?" pop-up safeguards with flashing lights and gongs, order a mandatory, week-long "DON'T DO THIS. DOING THIS WILL CAUSE FUCK UPS AND SHIT." training seminar for all end-users and require the process to be authorized by two separate people on opposite sides of the building ; and there's still going to be one genius to do it anyway and be surprised by any resulting fuck-up.
Probably more than one, akshully.

Fool-proof is not realistic - they're always releasing better fools, ya can't keep up.

[septimus]

The hyper-losses of Knight Capital are another example of the risks imposed by hyper-activity in the financial sector. I didn't think these dots were so hard to connect.

Should government institute laws to force people to fasten seat belts? Opinions differ; some might accept such laws because unbelted drivers increase hazard for others; some not.

My approach is the libertarian (small-l) approach where costs are adjusted through taxation. Taxes on cigarettes are an obvious example; they reduce unproductive behavior, raise revenue, and help compensate society financially for the costs imposed on it by smokers.

Those who think the "hyper-efficient" high-volume financial markets we see today provide a strong benefit to society may leave the room now! My remarks are directed at rationalists who grasp that today's hyper-markets serve the general public poorly, serve average investors poorly, and benefit no one but the big financial traders themselves. And please do note that the high-stakes game played by the too-big-to-fail industry are ultimately variations on "Heads we win; Tails the taxpayer and general public loses."

I do not propose that government outlaw bad software. I do not propose that government outlaw high-speed trading. A simple small transaction tax would reduce hyper-activity and thus its associated risks, and would raise significant revenue.

And please don't trot out, for the 3rd or 4th time, a tired pdf showing poor results from a 0.5% tax when current proposals are for a 0.03% tax.

[Latro]

Originally Posted by Voyager

In the Times today I read that there was a new capability or type of trading launched, and Knights wanted to be first, ahead of more cautious competitors. If that is correct, and they were shooting for a deadline, then I wouldn't be surprised if they skimped on internal testing to meet it. The problem described in the Register should have been easily caught, but testing takes time and a good test environment costs money.
CEOs get a fortune because they are supposed to be so much better than lackeys like us. But when they screw up they get another fortune. Ancient kings and emperors who took the throne got the palace and the gold and the serving wenches - but when they screwed up their heads went on a pike. When they lost the big battle they didn't get to depart with half the gold. If we stuck the heads of failing CEOs on a financial pike maybe they'd try a little harder.

Originally Posted by Enkel

The funniest part is that somewhere, there is a programmer going "Oh, crap!"

Because it is the programmer who will get the blame for this. Not the CEO who went against the warnings of the programmer and wanted it live ASAP, NOW!!, YESTERDAY!! "Why isn't this finished yet?!" "I'm starting to wonder about your programming skills and if you are the right man for this job!" ,"We have reached the deadline, just put it live already." "No, don't give me all that technological crap, I don't have to know about that, that's your job, not mine."

No, the programmer will be blamed for not doing his job properly.
"What, you warned us?" "Can't remember, you obviously weren't clear enough." "You should have been more vocal in your objection." "I'm starting to doubt whether you are the right man for this position."

[ralph124c]

Why are financial markets designed in this way (such that "program trading" can take advantage of miniscule price differences in a stock)? It seems to me that the stock market should be designed to promote liquidity, not encourage hyper trading schemes. In any event, the big funds that hold shares for long periods of time (like Buffet's Berkshire Hathaway, Fidelity Magellan, etc.) are affected by the activity-why don't they put pressure on the trarders to stop this nonsense?

[TriPolar]

Originally Posted by ralph124c

Why are financial markets designed in this way (such that "program trading" can take advantage of miniscule price differences in a stock)? It seems to me that the stock market should be designed to promote liquidity, not encourage hyper trading schemes. In any event, the big funds that hold shares for long periods of time (like Buffet's Berkshire Hathaway, Fidelity Magellan, etc.) are affected by the activity-why don't they put pressure on the trarders to stop this nonsense?

Because those trarders own the country.

[Trom]

Originally Posted by ralph124c

Why are financial markets designed in this way (such that "program trading" can take advantage of miniscule price differences in a stock)? It seems to me that the stock market should be designed to promote liquidity, not encourage hyper trading schemes. In any event, the big funds that hold shares for long periods of time (like Buffet's Berkshire Hathaway, Fidelity Magellan, etc.) are affected by the activity-why don't they put pressure on the trarders to stop this nonsense?

Because on a whole, HFTs are beneficial.

From a Q&A with gigantic, buy-and-hold Vanguard's CIO:

Q: What is your take on high-frequency trading [HFT]? Is it helpful or harmful to individual investors?

Sauter: The term high-frequency trading is applied to many different types of participants and strategies in the market. Market makers are high-frequency traders. We need market makers to provide liquidity and for price discovery. High-frequency trading is also used for arbitrage opportunities. We want the derivative markets to be in line with the cash markets. We want futures contracts to be in line with the underlying security. It’s the same with ETFs. Arbitrageurs use high-frequency trading to keep markets in synch with each other. Maybe at the other end of the spectrum there are people abusing the system. The SEC is trying to identify people doing that. It’s a very small percentage of high-frequency trading. Investors have benefitted from changes in the market including HFT. Transaction costs have declined precipitously the past 10 to 15 years. Net-net, we’re better off with HFT than without. Individual investors have benefitted more than institutional money managers. Spreads have narrowed dramatically. The bid and offer are thinner than they used to be; it used to be deeper. But most traders are not trading in enough size to worry about market impact. We benefit from tighter spreads but we still have to be careful.

my bolding

[JKilez]

Originally Posted by septimus

Retail investors wouldn't have overpaid by 29% if they used limit orders, but a previous thread covered reasons not to limit; and there are others.

What's wrong with limit orders?