Wall Street’s Robot Uprising Quickly Quelled

Though some day traders referred to yesterday's software glitch to something out of the Terminator movies, long-term investors have little to worry about.

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Brendan McDermid / Reuters

Knight Capital Group Inc said that on August 1, 2012, that a "technology issue" had affected the routing of shares of around 150 stocks to the New York Stock Exchange.

To hear some tell it, it was as if Wall Street were facing its very own “rise of the machines,” a strange and chaotic robot uprising that wreaked havoc amongst a wide assortment of stocks yesterday morning. “The robots are attacking Wall Street’s integrity,” the New York Post declared. “It’s like technology out of control,” one floor trader at the New York Stock Exchange told Bloomberg. “The machines have taken over,” a market consultant told the New York Times. One trader wondered if poor humans would be left to fend for themselves in “a terminator infested market ran by algos and [High Frequency Traders,] slaughtering the last of the human day traders that are left.”

But was it really as dire as all that? For traders in the particular stocks affected, sure, if they didn’t just sit on their hands and wait for the trouble to be resolved. For Knight Capital, the market maker whose software glitch caused the chaos, definitely. For long-term investors, not so much.

So what exactly happened? An as-yet-unspecified “technology issue” at Knight Capital sent shares in 148 companies careening up and down wildly shortly after the opening of US markets yesterday. The stocks affected ranged from well-known names like Goodyear, Alcoa and Bank of America  to small stocks like Wizzard Software, which shot up 300% (and quickly fell back down again). After the dust settled, the New York Stock Exchange announced it was canceling trades in the six stocks whose share prices were most affected by the glitch, including Wizzard.

But this was no repeat of the “Flash Crash” of May 2010, which sent the Dow plunging 600 points in a matter of minutes. This time, floor traders quickly realized that something weird was afoot, and many took the volatility in stride. “Before all the hoopla even died down, we were back up and running, “ one nonplussed trader told the Wall Street Journal. ““People were scratching their heads, but it wasn’t a sense of panic,” Arthur Hogan of Lazard Capital told Bloomberg.

The big loser in the whole affair was Knight Capital, which may find itself on the hook for anywhere from $170 million to $300 million in trading losses after its software gobbled up shares of stocks at artificially inflated prices. Knight saw its own shares plunge by a third in trading Wednesday, as exuberant bears on message boards predicted imminent bankruptcy for the firm.

Obviously electronic snafus of this sort are a big, and ongoing, concern for traders and for anyone concerned about the smooth functioning of the markets. And this won’t be the last time the “algos go mad” by a long shot.

But it’s a little strange that so many observers are suggesting that this glitch could seriously erode the trust of ordinary investors in the markets. The recent glitches, Nathanial Popper of the New York Times wrote, “have stoked suspicions that stocks are safe only for specialists, and sometimes not even for them.” The New York Post seconded this emotion, suggesting that “the glitches could continue to erode Main Street’s confidence in the equity markets.” An article on Bloomberg, meanwhile, wondered if the glitches would cause even more small investors to pull out of mutual funds.

As Matt Koppenheffer points out in a piece on The Motley Fool, such a dramatic result seems unlikely:

If we go back to the 2010 flash crash, average S&P 500 trading volume was 2.4% higher in the three months following the blip versus the three months prior to it. It certainly doesn’t look like the big robot-induced dip convinced people to stop using the markets, so I don’t see why its punier younger sibling should.

Perhaps more to the point: glitches like this shouldn’t scare off investors with a time horizon longer than a couple of minutes, since they have essentially zero effect on long-term investors. The stocks affected by yesterday’s glitch returned more or less to their original prices yesterday; the overall market was barely affected. Most investors who didn’t happen to catch the chatter about it yesterday on CNBC are unlikely to know that anything even happened.

I’m far more worried by the possibility of robots stealing my luggage.

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