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| Investors Column Archive | | For archival copies of the Investors Column click here... | | | | 30th May 2010 | BEWARE FAT FINGERS AND BLACK BOXES
Was a ¡®fat finger¡¯ to blame for Wall Street¡¯s recent implosion?
The US Securities & Exchange Commission has launched an investigation after the main measurement of the US market, the Dow Jones Industrial Average, fell by 1000 points a few weeks ago. This was the biggest points drop since 1987.
Some shares were particularly badly hit. Consulting and outsourcing giant Accenture fell from US$42.30 to just 4USc, water sector investment fund PowerHouse dropped from US$18 to 10USc and even conservative household goods producer Procter & Gamble slumped from over US$60 to around US$37.
Once it was found there was no market panic, those shares recovered much of their losses by the end of the day.
The index rebounded the next day after it was announced that ¡°erroneous¡± trades had caused the slump. In other words, somebody, somewhere had made a mistake.
One theory is that a trader tried to sell a million dollars worth of a share or shares and instead put in an order for a billion dollars ¨C the so-called ¡®fat finger¡¯ problem where the wrong key or keys are hit on a keyboard.
Another contributing factor is likely to have been the ¡®black box¡¯ trading systems that act in microseconds and have no human input. These would have seen someone placing big sell orders and followed suit.
As US market analyst Sol Palha notes, at one stage the US index lost 600 points in just seven minutes.
¡°Humans could never move that fast. There are rumours that a trader entered billion instead of million and this triggered the massive sell off. Whatever the cause, the main wave of selling was initiated by computers.¡±
Such computers use quantitative programs that determine which investment strategy is going to yield a superior rate of return.
¡°It is assumed that because computers have no emotions, they should be better at trading as they can move in and out of the markets extremely rapidly. The scary part is that the computer renders the final decision.
¡°There is one problem, these computers are programmed by humans and one glitch in the program can cause havoc.¡±
This is a big deal since, by some counts, computers are responsible for as much as 70% of daily trading volume on the New York Stock Exchange.
As far as I am aware, NZ and possibly even Australia are too small, and the computer systems too expensive, to justify having black boxes to trade shares.
However, that won¡¯t stop our markets collapsing if the same happens in the USA and we have to hope that action is taken to ensure it does not happen again.
David McEwen is Chief Investment Officer of Investment Research Group Ltd www.irg.co.nz. A disclosure statement is available free of charge on request.
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