The "Flash Crash" threatens to return

A few months ago we examined the impact of automated, computerized trading systems on stock exchanges around the world. A commentator noted at the time:

The digitised financial machine does not work for us: we work for the machine. And I do not believe that our political leaders have the faintest idea how to bring it under control.

Now CNBC warns that such computer systems risk bringing down the entire global stock market trading system. Here's an excerpt from their article.

... could 2012 produce a repeat of the “flash crash”, the bizarre episode that hit the U.S. equity markets back on May 6 2010?

Think about it for a moment. A full 18 months have passed since the strange episode that caused the Dow Jones to tumble 650 points in half an hour, wiping $850 billion off share prices, before rebounding. Since then, the issue has faded from view amid the eurozone drama.

But to this day, nobody has fully explained what really happened on May 6. Nor is there any evidence that the fundamental problems that caused the flash crash have been resolved. That leaves some scientists fearing that not only is a repeat of that flash crash possible, but it is probable — and next time round, it could be even more damaging.

To understand this, take a look at a fascinating transatlantic research paper published by the Bank for International Settlements. One of the paper’s co-authors is Dave Cliff, formerly a financial trader who now runs the UK government’s Large-Scale Complex Information Technology Systems project, an endeavour that analyses the risks of IT systems in sectors including healthcare, nuclear energy and finance. The other, Linda Northrop, runs a similar project at Carnegie Mellon University, which was initiated a decade ago by the US military.

. . .

... these researchers believe that the flash crash was not an isolated event; on the contrary, it was entirely predictable given how IT systems have proliferated to create a system of systems that is now interacting in unpredictable ways that regulators and investors cannot comprehend, far less control.

. . .

... the risks and near misses are rising all the time. Take May 2010. At the time, the wild gyrations in prices were deemed shocking. However, Cliff and Northrop think it could have been dramatically worse: if the systems failure had been a little later that day, prices would not have had a chance to recover before the US market’s close, which would have caused carnage when Asian and European markets opened.

“The true nightmare scenario would have been if the crash’s 600-point down-spike, the trillion-dollar write-off, had occurred immediately before [US] market close,” they note. “The only reason that this sequence of events was not triggered was down to mere lucky timing. . . the world’s financial system dodged a bullet.”

And such luck may not be repeated.

There's more at the link.

As if we didn't have enough economic bad news to worry about already, what with out-of-control deficit spending by the US government, the Euro crisis on the other side of the Atlantic, and China's economy showing signs of hitting the wall as well! Oh, well . . . Happy New Year to all investors, I guess!

Peter