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Wall Street crash exposes world of electronic trading

Regulators picking through the rubble of dramatic Wall Street crash have exposed a Byzantine system of electronic trading that may have propelled the sell-off.

business Updated: May 16, 2010 21:43 IST

Regulators picking through the rubble of dramatic Wall Street crash have exposed a Byzantine system of electronic trading that may have propelled the sell-off.

In 10 bone-shaking minutes on May 6, the Dow Jones Industrial Average — representing the 30 most venerable US firms — briefly lost almost a tenth of its value.

Open-jawed investors blanched as the pensions and savings of millions of Americans were decimated, along with the livelihoods of countless more. Days and a partial recovery later, the most fundamental question has still not been answered: What happened?

The Securities and Exchange Commission, the New York Stock Exchange and even President Barack Obama have vowed to uncover the causes of the fall.

In the meantime, homespun theories have been shot down one-by-one.

The major US stock markets said a glitch on their trading platforms was not to blame.

Citigroup angrily brushed aside the notion that one of its traders had mistakenly hit the billion rather than million button on a sale.

Some bolder television commentators speculated that cyber-terrorism may be to blame, although evidence appeared to be lacking.

Whatever the trigger, blame for the severity of the crash is now aimed squarely at algorithmic trades.

At their simplest, "algos" are used to buy or sell shares at a certain trigger point, to limit losses or seek new profits. They are responsible for anywhere between 60 and 90 per cent of trading on a normal day. "One programme can trade thousands of stocks in milliseconds," explained Terrence Hendershott, a professor of finance at the University of California, Berkeley.

New figures for consumer spending or one stock's deviation from the broader price trend can trigger a rash of buying and selling while a human trader is off getting coffee. Hendershott speculated that the crash could have been caused by a badly programmed algorithm, or a trader's mistake.

That could have sparked automated selling that forced stock prices down and triggered a cascade of other automated sales. This domino effect could have occurred at such a pace that humans had no idea what was happening.

Thanks to algorithms, 10 minutes is now a very long time in the stock market.