Momentary Financial Crisis... And A Lesson In Unintended Consequences
from the watch-the-automated-trades-go-wheeeeeeeeee dept
Basically, there's a system for the NY Stock Exchange and the NASDAQ, called the Liquidity Replenishment Point (LRP), which is designed to stop electronic trading on stocks in freefall. The idea, of course, is to prevent the algorithms from going nuts. But, the LRP only works on those two exchanges, and we're in a world now where there are a bunch of other, electronic exchanges, that now handle an increasing percentage of stock trades -- and electronic trading on those exchanges is not stopped when the LRP is triggered. So, now things actually get worse, because orders that used to be spread more widely concentrate on these other exchanges by automatically jumping from the NYSE and NASDAQ to those alternative routes, and it can swamp those systems, which have a lot less money available. As Bloomberg explains:
While the system is designed to restore order on the Big Board, trading is so fast during times of panic that orders routed past the exchange may swamp other venues and exhaust buy orders, said Angel at Georgetown.And, speaking of unintended consequences, in talking about this very thing, Felix Salmon points to a blog post by Kid Dynamite explaining why the plan to cancel many of the errant trades is monumentally stupid and likely to create more unintended consequences in forgiving people for doing stupid things, and taking away incentives for others to step in and fix things:
That's when prices may plummet as orders execute against so-called stub quotes from market makers. Brokers can set the quotes as low as a penny a share because they're never expected to be used.
if buyers who step in later see their trades canceled, it removes all incentive for them to step in - and then you don't get the bounce back that we saw! Think about how much havoc it causes a trader who astutely bought cheap stock, then sold it out at a profit. He's now short! Or, he spent the entire day wondering if his order would be canceled, in a state of limbo. What's the alternative - that traders should just assume that the orders will get canceled, and NOT buy stock? Guess what - if no one buys, the stock stays cheap! SOMEONE has to buy, and that someone shouldn't be penalized in favor of remedying the ignorance of the seller who screwed up.Ah, setting off more unintended consequences in response to other unintended consequences. Sometimes you just have to let those who made a mistake take responsibility for their mistakes.