Algorithmic Trading, Promise and Perils
Source: Barry Ritholtz
Bloomberg Echoes looks at the history of computer driven snafus:
When machines replace seasoned traders and market makers, mistakes can occur at dizzying speed. It happened with the notorious “flash crash” on May 6, 2010, and again on Aug. 1 this year, when software at Knight Capital Group Inc. (KCG) malfunctioned, triggering unintended trades and leading to a $440 million loss for the company.
Ironically, Knight Capital Group was originally known as a market maker, with trading specialists who oversaw trades on each side of a security to ensure the market functioned in an orderly and efficient manner. The company’s troubles once again show the extent to which Wall Street now relies on algorithmic programs to execute its trades, for better or worse.
Although many in the financial world have expressed concerns that a new era of automated finance is destabilizing the markets, algorithmic trading isn’t new ― it’s almost as old as computers themselves . . . Algorithmic trading soon evolved into nanotrading. In the signal extraction world, a second is an eternity. An algorithmic-trading facility located within a block or two of the New York Stock Exchange (NYX)’s servers could see trade data a millisecond sooner than a trading facility half a state away. A modern computer can execute millions of calculations in that millisecond. Such signal theory and nanotrading soon required that humans were all but removed from trade execution.”
The entire article is worh reviewing.
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