Technical Trading Snafus Send Stocks Reeling

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Investors have plenty to worry about already — the economy, corporate prospects, whether the bull or the bear will reign on Wall Street. Increasingly, another worry has been added to the mix: the market’s vulnerability to technology-driven mayhem.

What Keeps Me Awake Now

Technological trading snafus are starting to add up for the nation’s stock markets. A brief interruption on September 4 in the trading of a limited number of stocks on Nasdaq was the exchange’s second glitch in less than two weeks. The earlier was the so-called Flash Freeze, a three-hour shutdown due to a software flaw that halted trading in the exchange’s 3,300 listed securities — including Apple, Google and Facebook.

That glitch followed last spring’s #Hash Crash (when the Dow Jones industrial average plunged 144 points in two minutes after hackers compromised the Associated Press Twitter feed and posted a fake tweet about an explosion in the White House), and the #Hash Crash followed the Flash Crash (the nearly $1 trillion plunge in 2010 tied to one investor’s flawed trading algorithm).

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In between were technical problems that botched initial public offerings for Facebook and BATS Global Exchange — the latter on BATS’s own exchange. A computer hiccup at trading firm Knight Capital cost it more than $450 million.

Cyber crime, too, is a major worry. In a recent survey, some 53% of the world’s securities exchanges said they had suffered a cyber attack in the past year, according to a paper published by a consortium of world securities regulators and a federation of exchanges. Attacks so far have been aimed at disruption rather than financial gain. Still, 89% of exchanges surveyed agreed that cyber crime poses a system-wide risk to world securities markets.

Are tech-driven disruptions, whether malicious or accidental, an inevitable part of modern life, like cell phone freezes, PC crashes and occasional power outages? Or are they an indication that our markets — and their regulators — have failed to keep pace with lightning-fast technology?

The more complex the system, the more parts that can break, says Georgetown University finance professor James Angel. But, he adds, “everyone at these companies, and the Securities and Exchange Commission, is breathing down the exchanges’ necks” to reduce the occurrence of such malfunctions. Earlier this year, the SEC proposed rules that would compel exchanges, other trading systems, clearing agencies and others to develop, test and maintain their systems to make sure that certain technological standards are met. A summer cyber security exercise called Quantum Dawn 2 tested the industry’s capability to respond to cyber attack.

Still, critics contend that the markets have become too fragmented and too fast-paced for their own good. There are now 13 separate exchanges and some 50 so-called dark pools (trading venues for institutional orders, which are unavailable to the public), and each has different technology, operating speeds, order types and rules, says Sal Arnuk, of brokerage Themis Trading. “There’s no way you can eliminate the chance of failure in such a complex mousetrap,” he says. The need for speed can be problematic if it leads to software programs that are streamlined at the expense of safeguards, says Larry Tabb, of the TABB Group, a financial markets research firm.

But although the recent debacles can hurt confidence, they shouldn’t loom large for most individual investors. The markets operate effectively most of the time, says Tabb, and individual investors with a long-term perspective shouldn’t be tremendously concerned about short-lived derailments. For insurance, it’s best when trading to use limit orders, which allow you to buy or sell securities at a specific price or better.

Anne Kates Smith brings Wall Street to Main Street, with decades of experience covering investments and personal finance for real people trying to navigate fast-changing markets, preserve financial security or plan for the future. She oversees the magazine's investing coverage, authors Kiplinger’s biannual stock-market outlooks and writes the "Your Mind and Your Money" column, a take on behavioral finance and how investors can get out of their own way. Smith began her journalism career as a writer and columnist for USA Today. Prior to joining Kiplinger, she was a senior editor at U.S. News & World Report and a contributing columnist for TheStreet. Smith is a graduate of St. John's College in Annapolis, Md., the third-oldest college in America.