When the machines take over
As a massive movie fan, I’m familiar with the theme of the machines taking over, whether it is “War Games”, “Terminator” or “The Matrix”. But that’s science fiction, right?
Well, no. Financial markets are now so fast-moving and complex that increasingly decisions to buy or sell certain stocks or derivatives are made by computers using programs based on what is called an algorithm.
On 6 May 2010, the Dow Jones industrial average in New York suddenly plunged by almost 1,000 points in around 20 minutes. Why? You guessed it. A computer decision based on a sell algorithm.
The staffs of the Securities and Exchange Commission (SEC) and the Commodity Futures Trading Commission (CFTC) in the United States have just released a joint report presenting their findings regarding the market events of that fateful day.
If you have a mind to do so, you can read the report here. But, for the moment, let’s just pick out a bit from the executive summary:
“One key lesson is that under stressed market conditions, the automated execution of a large sell order can trigger extreme price movements, especially if the automated execution algorithm does not take prices into account. Moreover, the interaction between automated execution programs and algorithmic trading strategies can quickly erode liquidity and result in disorderly markets.”
Another way of putting this is: don’ t put too much trust and responsibility in computers – or else …