For Safety's Sake
October 11, 2010
I hadn't been at the lunch table more than 20 minutes. And my tablemate - the chief regulatory officer for a stock exchange based in Kansas - might as well have just said, "put a fork in it."
The Securities and Exchange Commission and the Commodity Futures Commission had released their findings on the causes of the May 6 Flash Crash.
Here I was, sitting in the Sheraton Hotel at the Overland Park Convention Center. Directly implicated was Waddell & Reed, a mutual fund company. The 73-year-old firm's headquarters were just six miles down the road.
The trigger event was the initiation of a sell program on 75,000 E-Mini contracts, worth $4.1 billion, at 2:32 p.m. According to the report:
"This large fundamental trader chose to execute this sell program via an automated execution algorithm (Sell Algorithm) that was programmed to feed orders into the June 2010 E-Mini market to target an execution rate set to 9% of the trading volume calculated over the previous minute, but without regard to price or time."
This trader had pursued a similar large-scale selling program before, the findings noted, and used manual means to enter the trades over the course of a day. The firm also used "several automated execution algorithms which took into account price, time and volume." That time, it took more than five hours to execute 75,000 contracts.
This time, it took just 20 minutes. High-frequency traders and intermediaries took the initial batch of orders and the Sell Algorithm increased the rate of orders it was feeding into the market.
Maybe it's just me. But where were the controls on the Sell Algorithm?
Where were the brakes?
And when will the SEC and CFTC mandate pre-trade controls on time and price on all algorithms allowed to send orders into the marketplace?
In this case, the user ran the show. The algorithm, from Barclays Capital, allowed Waddell & Reed to dictate the way it sold the E-Mini contracts.
I squelched the urge to drive down Lamar Avenue and find out how Waddell planned to foreclose the risk of overfeeding a frenzy in the future.
That can be left to the SEC and CFTC, which may have to dictate limits on pricing, timing and volume of electronic orders driven by math.
Or, under their wings, set up an Algorithmic Trading Commission, for risk control and oversight.
For safety's sake.