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NASDAQ'S Pause: Market Size and Complex Systems Equals More Glitches

Source: WSJ

Posted on 23 Aug 2013 by Neilson

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NASDAQ'S HALTThe root cause of Thursday's Nasdaq Stock Market trading halt can be traced to a single word: complexity.

Trading in stocks today takes place on dozens of trading venues: 13 stocks exchanges; some 40 dark pools, or private trading platforms; and countless "internalizers," or trading operations in which stockbrokers match trades inside their own walls. Increasingly, all this trading takes place at speeds measured in the millionths-or billionths-of a second inside giant data centers housing state-of-the-art supercomputers.

While some traders and economists shrug their shoulders and write off recent problems-such as this week's options trading snafu or the 2010 "flash crash"-as the price of progress, others say the problems are becoming so widespread that exchanges and big firms need to be held to a higher standard.

"It shows that corners are being cut and not enough is being spent on testing these systems," said financial historian Richard Sylla of New York University's Stern School of Business.

Nasdaq's trading glitch started inside the so-called securities information processor, or SIP, data feed. The feed "provides continuous quotations from all market centers trading Nasdaq-listed securities," according to the SIP plan's website.

Because much of the market relies on the SIP feed to get Nasdaq stock prices, a glitch in the SIP feed can send ripples into the rest of the market that can become tidal waves.

Something similar happened on May 6, 2010, the so-called flash crash that sent the Dow Jones Industrial Average plunging nearly 1,000 points in minutes. According to a regulatory report, a single fund company unleashed a wave of sell orders in the futures market during a period of high market volatility. High-speed traders bought those contracts and rapidly sold them, spreading downward pressure throughout the market.

But because of the complexity of the events, it took regulators months to reach that conclusion-one many still disagree with. Indeed, the cause of the flash crash remains hotly disputed even today.

Then there was the "Knightmare" last August, when Knight Capital Group Inc. sent waves of erroneous trades into the market that resulted in losses of nearly half a billion dollars in less than an hour. The complexity of Knight's trading operation, and the nature of the problem-faulty installation of software-was in part a reason for the delay in shutting down the trades.

Prof. Sylla points to other recent market disasters involving computers run amok.

On Tuesday, Goldman Sachs Group Inc. sent waves of bad orders into the stock-options market, roiling prices and disrupting trading.

Nasdaq this year paid a fine to settle Securities and Exchange Commission civil charges stemming from technical issues that helped cause widespread problems with Facebook Inc.'s 2012 initial public offering.

Those are some of the more-prominent examples of computer-related troubles that have hurt stock traders and damaged the market's reputation in recent years.Stock trading has from time to time been delayed, suspended or disrupted by smaller-scale computer breakdowns.

"What is hard to understand is how we've had a half a dozen of these breakdowns" in just a few years, said Jeffrey Sonnenfeld, senior associate dean at the Yale School of Management.

Prof. Sonnenfeld said Nasdaq OMX Group Inc.Chief Executive Robert Greifeld and the SEC both should take responsibility for solving and preventing such problems and for explaining to investors what is wrong. "We should be hearing from [SEC Chairman] Mary Jo White as much as anyone," he said. "I fault the SEC as much as the exchange" for leaving investors in confusion, he said.

Ms. White, in a statement about the Nasdaq problem, said, "Today's interruption in trading, while resolved before the end of the day, was nonetheless serious and should reinforce our collective commitment to addressing technological vulnerabilities of exchanges and other market participants."

Nasdaq on Thursday said it would work with other exchanges that are members of the SIP to investigate the issues and that it supported any necessary steps to enhance the platform.

Trading problems have become so common that many Wall Street insiders are almost inured.

"People understand it and are kind of used to it," said Gerry Milligan, head of U.S. program trading for Instinet LLC, one of the top 10 trading firms in Nasdaq securities.

If the two major exchanges were operating in a more-competitive environment, they would be forced to improve their systems or see clients walk away, a problem that helped destroy Knight as an independent company, said some economists. But most ordinary investors have little choice but to use them. The only options for ordinary investors are to take a hit when exchanges break down, or look to regulators to require exchanges to operate more effectively.

"In an uncertain world, the fact that these computers are failing with greater frequency is going to scare people away from the market," Prof. Sylla said.