As if investors needed another reason to be wary of Wall Street, on August 1st, a brief tempest hit the stock market resulting in hundreds of millions lost. It’s source?

A technical glitch.


A “Steady Hand” Loses its Grip

Upon the sound of the opening bell that Wednesday morning, a rapid-fire buying and selling spree unfolded, resulting in around 148 stocks trading at 20 times more than their average volume. This strange trading activity resulted in high-volume price swings of up to 30 percent.

Forty-five minutes later, almost as soon as it had started, the stock market stabilized, leaving everyone to wonder what had just happened.

We now know that the cause of the market’s wild ride was a software glitch in trading firm Knight Capital’s computer systems. The technological trouble, which cost the company $10 million per minute, caused many to wonder if this well-established firm, described by Forbes as “one of the steady hands of this market,” would survive the month.

The Pitfalls of High-Frequency Trading

Knight Capital typically executes approximately 4 million trades per day, at a value of around $24 billion. The company’s technological infrastructure, which enables the firm to handle such a high volume of trade, was, until last week, the company’s pride and joy.

“We spend tens of millions of dollars every year making our technology platform better, faster and more reliable,” wrote Thomas Joyce, Knight Capital’s Chairman and CEO, as part of a written testimony to the House Committee on Financial Services back in June.

Just a few weeks later, that technology platform, lauded by Joyce, would cost Knight Capital $440 million. The incident has ignited a debate about who is regulating the technology that now controls the stock markets.

In a New York Times Op-Ed, Joe Nocera writes:

“Wall Street is now as blindly reliant on computers, on algorithms, on high-frequency trading, as it was once blindly reliant on the risk models that allowed ‘toxic bonds’ to be rated Triple A. Wall Street has created its own Frankenstein. The machines are now in charge.”

Many are questioning why Knight Capital hadn’t adequately tested its new software before letting it run rampant on the capital markets. Others are calling for the SEC to regulate the testing of the software used by trading firms to ensure that such incidents don’t happen again.

Reuters reports:

“The U.S. Securities and Exchange Commission has been grappling for years with ways to create a national market system that uses technology to ensure that orders to buy and sell shares are sent to the best possible exchange. After the shock of the 2010 Flash Crash, it also began exploring fail-safe mechanisms to prevent technology-induced disasters.”

Knight Capital Looks to the Future

Joyce, who has won nothing but praise for his handling of the crisis, announced on Monday that Knight Capital Group has secured a $400 million capital injection from a group of investors, allowing it to cover last week’s massive losses. The rescue package will give the new investors approximately 70% ownership of the firm, and will allow Knight Capital to avoid the threat of bankruptcy. Upon announcement of the deal, the company’s already battered stock price dropped another 25%, with investors citing concern over the company’s future.

Besides Knight itself, the biggest victim of Wednesday’s market turbulence is the industry’s reputation. With recent technical problems — the Flash Crash two years ago, NASDAQ’s botched Facebook IPO, in which Knight Capital was also involved, and now this — the market has certainly been marred, and may feel like an even riskier place to invest than ever. Regardless of its ability to weather this storm, Knight Capital’s computer glitch could have long term consequences for the health of Wall Street.

What do you think should be done in the wake of Knight Capital’s computer glitch? Are the markets no longer in our control? 

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