Looking into a Market Abyss

 Posted by on May 7, 2010  Add comments
May 072010

Sitting on my desk in my office is a model of one of the most dangerous cars in the history of sports car racing. It is a Mercedes 300SLR. On June 11, 1955, at the Le Mans race, a 300SLR driven by French driver Pierre Levegh was involved in an accident in which 82 people (including the driver) were killed. This tragedy sent a shock through the racing world, and the thinking about race car performance, design and safety was changed forever.

Now, in racing, it is clearly possible to produce race cars that can go 250, or 300 or perhaps 350 mph and stop on a dime. Human beings, even with computer assists, can’t drive such cars safely on the race track. So, it is not that such cars cannot be built, but that such cars would be too dangerous: too dangerous for drivers, too dangerous for fans, too dangerous for the sport. So racing cars today are regulated; there are rules, regulations and rigorous testing regimes which, if violated, yield significant fines and penalties. Racing is still one of the most popular sports in the world, but it is not as fatal as it was 55 years ago (though, it is likely we will see some significant accidents in the future as drivers and racing teams continue to push the envelope).

May 6th, 2010, could have been as fatal to the world’s economy as the ’55 Le Mans tragedy was to the fans alongside the pits. Yesterday, the U.S. Stock Market plunged 1,000 points (approx 10%) in a matter of minutes. (See this morning’s New York Times article, “Market Drop Fueled by a Crisis, Anxiety and an Error“, by Floyd Norris.) As of the end of trading, no one could put their finger on the trade (or trades) that triggered this sell off, but the markets have already begun to look into the event and make adjustments. The NASDAQ, for example, has issued a statement that it will cancel all trades executed between 2:40 p.m. to 3 p.m. showing a rise or fall of more than 60 percent from the last trade in that security at 2:40 p.m or immediately prior (Reuters). Fortunately, markets bounced back almost as quickly, ending the day down only a mere 335 points or 3.5%.

After all of the dust had settled, everyone was asking whether the market had collapsed or whether, it was something else. Mark Fisher, of MBF Clearing, a widely experienced (35 years) trader and an expert on computer trading who rarely speaks publicly, when asked on CNBC’s Fast Money about whether this is the result computerized trading, said “This is the Matrix. We’ve got to slow this thing down or we’re going to see today’s actions repeated.” Fisher called for immediate action from the markets to put in governors that would come into play when market volatility exceeded certain limits. Listening to Fisher, I was immediately reminded of an article that I saw in a recent edition of the MIT Technology Review.

Today’s stock market has become a world of automated transactions executed at lightning speed. This high-frequency trading could make the financial system more efficient, but it could also turn small mistakes into catastrophes.

If Manoj Narang is about to bring down the markets, he’s certainly relaxed about it. Narang, who wears a goatee and wire-frame glasses, is casually dressed in a brown shirt and dark gray sweatshirt. Sitting on a swivel chair with one leg tucked under the other, he seems positively composed, especially for a man who has just bought and sold 15 million shares with a total value of $600 million. For Narang, however, such volume represents just the start of a normal day. Though it’s about noon on a Friday morning, he has barely begun.

(Excerpted from “Trading in Shares in Milliseconds” by Bryant Urstadt, Technology Review, January/February 2010)

High speed computers and communications are the weapons of choice of today’s leading hedge funds traders. The technology involved is moving so fast that even the title of the article quoted above, published by one of the leading technical magazines in the world, is already out of date—the market is trading not in milli-seconds but in micro-seconds! But human beings are not built with sensors, brains, or response times that can to react to milli-second, much less micro-second, events. In the warfare between financial computers, either the computers themselves need to be smart enough to anticipate any activity—which they aren’t—or some sets of governors must be put in place to ensure that activity can be slowed down, or even stopped, until the system (e.g., markets) can stabilize.

Over the last 50 years, computers and communications have reshaped many of the most important elements of the financial markets, but today’s spike should be a warning.

Side note: The inquiry into the ’55 Le Mans tragedy established that the accident was caused not only by cars going too fast, but by one car, a Jaguar with newly perfected disk brakes, slowing too quickly. The result was that the Jaguar in question slowed faster than the following Aston Martin’s driver expected which caused the Aston Martin driver to swerve into the path of the Mercedes which used the Aston’s rear deck as a launch pad over the protective fence and into the crowd.


Ken Orr

Ken Orr is a Fellow of the Cutter Business Technology Council and Government & Public Sector practice and a Senior Consultant with Cutter Consortium's Data Insight & Social BI, Business Technology Strategies, and Business & Enterprise Architecture Practices.


  2 Responses to “Looking into a Market Abyss”

  1. Great post.

    Among other things, computing enables fast and massive synchronous psychosis.

  2. Nice observation, Ken.

    In the field of mathematics, within the specialties of complexity and chaos theory, there’s a metaphor known as “The Butterfly Effect”. Therein, it’s observed that for some types of systems, minuscule variations in initial conditions can produce large (and unpredictable) results.

    The stock market is most certainly among the world’s most complex and dynamic system. Regulation can be considered, in part, as a “damping effect” upon the amplitude of market variations. Were the events of May 6th a realization of the butterfly effect (perhaps 2 or 3 large “butterflies”, beating their wings in synchronization), leading to a market-wide hurricane?

    What about those trades in that critical 20 minute period of volatility, that “only” rose or fell 59% or less?

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