The Knight Capital Group fiasco highlights the danger that poorly-regulated computerized trading may be increasing volatility in already turbulent markets. On August 2 the Knight disclosed that failures in its automated systems caused unusual trading activity in an estimated 148 stocks listed on the New York Stock Exchange and resulted in a one-day $440 million loss to the Company.
This is only the most recent in a series of automated trading disasters that have left investors wondering whether regulators have been too slow to react to the high-tech revolution in trading. Last year, the SEC adopted a series of measures intended to safeguard against flash crashes fueled by automated trading programs. One innovation was the adoption of "circuit breaker" rules intended to arrest trading in individual stocks after large, extremely rapid changes in share prices, such as those seen in the notorious flash crash of May 6, 2010. However, these circuit breakers, which are tripped by changes in price rather than by spikes in volume, were largely ineffective in halting the spiral of automated trading generated by Knight.
The Knight incident provides a useful incentive for regulators to refine safety measures aimed at addressing the perils of automated trading. In the mean time, retail investors will be biting their nails.