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Rage of the Machines causes Stock Market crash

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  • Rage of the Machines causes Stock Market crash

    Stock Swing Still Baffles, With an Ominous Tone
    By GRAHAM BOWLEY
    Published: August 22, 2010



    The stock market mysteriously plunges 600 points — and then, more mysteriously, recovers within minutes. Over the next few weeks, analysts at Nanex, an obscure data company in the suburbs of Chicago, examine trading charts from the day and are stunned to find some oddly compelling shapes and patterns in the data.

    To the Nanex analysts, these are crop circles of the financial kind, containing clues to the mystery of what happened in the markets on May 6 and what might have caused the still-unexplained flash crash.

    The charts — which are visual representations of bid prices, ask prices, order sizes and other trading activity — are inspiring many theories on Wall Street, some of them based on hard-nosed financial analysis and others of the black-helicopter variety.

    To some people, like Eric Scott Hunsader, the founder of Nanex, they suggest that the specialized computers responsible for so much of today’s stock trading simply overloaded the exchanges.

    He and others are tempted to go further, hypothesizing that the bizarre patterns might have been the result of a Wall Street version of cyberwarfare. They say high-speed traders could have been trying to outwit one another’s computers with blizzards of buy and sell orders that were never meant to be filled. These superfast traders might even have been trying to clog exchanges to outflank other investors.

    Jeffrey Donovan, a Nanex developer, first noticed the apparent anomalies. “Something is not right,” he said as he reviewed the charts.

    Mr. Donovan, a man with a runaway chuckle who works alone out of the company’s office in Santa Barbara, Calif., poses a theory that a small group of high-frequency traders was trying to introduce delays into the nation’s fractured stock-market trading system to profit at the expense of others. Clogging exchanges or otherwise disrupting markets to gain an advantage may be illegal.

    Mr. Donovan indulges Wall Street’s increasing fascination with the charts by christening more of them each day, with names like Continental Crust, Broken Highway and Twilight.

    There is also the Bandsaw, a zigzag pattern of prices that appear and then abruptly vanish. There is the Knife, a sharp, narrowing price sequence. There is the Crystal Triangle, the Bar Code, the Mountain Range, each one stranger than the last.

    The truth of what happened on May 6 could be hiding somewhere in those mysterious configurations. Or it may lie somewhere else entirely. But 15 weeks later, the authorities are still looking for it. The Securities and Exchange Commission and the Commodity Futures Trading Commission plan to issue a final report on their findings in September.

    A preliminary report in May blamed a confluence of factors, including worries over rising sovereign debt and a lack of marketwide circuit breakers, but the new report is expected to go further.

    For now, this much is known: The markets were already down and on edge that morning as Europe’s debt crisis seemed to be spiraling out of control.

    As markets fell, a mutual fund manager in Kansas made a big sale of stock futures. The rout, some say, was worsened by a lack of coordination among the dozens of exchanges that make up the modern-day stock market. As the New York Stock Exchange slowed trading, rival exchanges that were more automated allowed the selling to continue.

    “It’s just madness to say we don’t know what caused it. We do,” said Steve Wunsch, a market structure consultant. “The crash was an inevitable consequence of creating multiple market centers.”

    That is one explanation. Others have pointed to the high-frequency traders, who use powerful computers to transmit millions of orders at lightning speed. Some of these traders, who now dominate the stock market, appear to have fled the market as prices went haywire.

    Then their computer programs might have dragged down exchange-traded funds, popular investment vehicles that fell sharply during the crash, said Thomas Peterffy, chief executive of Interactive Brokers.

    “Computerized arbitrage kicked in,” he said.

    But if Nanex’s theory is to be believed, computer algorithms might have been at work as well, knowingly or unknowingly wreaking havoc and creating data crop circles.

    “There is a credible allegation that there is seriously abusive practices going on,” said James J. Angel, a financial market analyst specialist at Georgetown University, “to the extent that somebody is firing in a very high frequency of orders for no good economic reason, basically because they are trying to slow everybody else down.”

    At a Washington hearing on the flash crash last week, Kevin Cronin, director of global equity trading at Invesco, a big fund manager, warned about “improper or manipulative activity” in the stock market.

    Traders at BMO Capital Markets in Toronto said they had also identified a “data deluge” a few minutes before the crash. They said people in the markets were poring over Nanex’s colorful charts.

    “Whether they are intentional or not, the regulators should be looking into it closely,” said Doug Clark, managing director of BMO Capital Markets.

    In an Aug. 5 letter to the Securities and Exchange Commission, Senator Edward E. Kaufman, Democrat of Delaware, warned about a “micro-arms race that is being waged in our public marketplace by high-frequency traders and others.” He said that the traders were moving so fast that regulators could not keep up.

    The idea that shadowy computer masterminds were trying to disrupt the nation’s stock trading struck many people as ridiculous. Wall Street experts generally characterize it as a conspiracy theory with little basis in fact.

    But some of the patterns suggested that traders might have been testing their high-speed computers, perhaps to see how rivals would react.

    Or it may just be that the computers produced so much data so quickly that exchanges simply could not cope with the onslaught.

    “We live in a day when things are measured in milliseconds,” said Sang Lee of the Aite Group, a financial services consulting company. “It is meant to be a level playing field, but if you have better technology you will have the edge.”

    Back in Chicago, Mr. Hunsader of Nanex is still not sure what his crop circles mean. But that does not stop him from admiring them.

    “The patterns are quite beautiful,” he said. “We can’t see any economic reasons for what they are doing.”
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