Computer trading glitches undermine investor confidence

Oct 9, 2012

Last Friday, India's main stock index suddenly experienced a 16% drop in value. $58 billion temporarily vanished in the blink of an eye thanks to a computer problem. 

Computer errors have also been blamed for Facebook's IPO troubles and 2010's infamous Flash Crash. Financial commentator Greg Heberlein and KPLU's Dave Meyer look at the world of computer driven, high-frequency trading on this week's Money Matters.

Small investors have the left the stock market in droves. The 2008 financial meltdown and the shaky economy are the two most obvious reasons for this. But rapid trading techniques also play a role in undermining confidence in Wall Street.

Big investors can now trade stock in a nanosecond. They can trade millions of shares to profit by a fraction of a cent per share. Smaller investors can't do this. 

Since the 2010 Flash Crash, an estimated $300 billion has left the market. Individual investors and even some bigger traders no longer trust the system.

High-frequency trading had several parents. Five years ago, the uptick rule in place most of the past century was revoked. Under the rule, an investor could not short, or bet against, a stock until the stock showed a price increase. The thinking was elimination of the rule would help modernize the market.  But it had unintended consequences. Without the uptick rule, traders can and do propel stocks downward without sufficient braking power.

Another factor was the elimination of the common fraction for pricing. In the old days, most stocks had to move at least an eighth, or 12.5 cents, per dollar. With the fraction gone, trades can occur in tenths of a second, hundreds or even less. That enables the big players to dip momentarily into the market to make a fraction of a penny per share profit on millions of shares.

Exchange-traded funds aren’t bad per se, but because their positions must be realigned at the end of each day, they’ve heightened rapid market movements.

What can be done? 

Restore the uptick rule. That alone would hobble high-frequency traders. 

Reconsider the fractions stocks can trade up or down. Go back to an eighth of a point, or more or less depending on the impact. 

Reassess ETFs to determine whether some trading restrictions should apply. No matter what adjustments are made, require those who manage high-frequency trading to allow individuals to participate. Let all have a shot, or none.

The stock market’s primary purpose was to give private companies a chance to acquire new capital. Today, it is estimated that the goal of 70 percent of trading volume is a quick profit, not a long-term investment.

If you know a game is rigged, you need to reexamine your participation.  And it appears a lot of people are doing just that.