Could Computers Protect the Market From Computers?

by Jason Zweig,  Wall Street Journal

The electronic markets keep getting their wires crossed—and investors are tired of getting shocked.

Two years ago, in the “flash crash” of May 6, 2010, U.S. stocks lost $1 trillion in roughly 20 minutes. Two months ago, BATS Global Markets, which runs the third-largest stock exchange in the U.S., yanked its initial public offering when its electronic market couldn’t smoothly execute trades in its own stock. A week ago, the launch of Facebook FB -3.39% stock on Nasdaq left countless investors unsure for days whether their trades had even been processed.

Exactly what caused these high-speed meltdowns still isn’t clear—largely because computerized trading has raced past anyone’s ability to monitor and control it.

“Until we have the ability to understand these problems both retrospectively and proactively, they’re going to continue to happen,” warns David Leinweber, a computer scientist and former investment manager who runs the Center for Innovative Financial Technology at Lawrence Berkeley National Laboratory in Berkeley, Calif.

Mr. Leinweber adds that while air-traffic controllers continuously track flights to keep the skies safe and weather experts watch hurricanes long before they make landfall, the financial markets have grown too dispersed and complex for humans to monitor.  …………….

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The Securities and Exchange Commission, which oversees the capital markets, has proposed a “consolidated audit trail” requiring exchanges to report every trade to a central repository, where they could later be analyzed.

The project is a “very high priority” for the SEC, says an official, but the agency doesn’t know when the rules for it will be completed. The main obstacle: agreeing on how to standardize the various formats that brokers and exchanges use to gather trading data.

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The SEC has estimated that a centralized order-tracking system would cost approximately $4 billion to set up and $2.1 billion a year to maintain.

Mr. Leinweber of Berkeley has a simpler, and probably cheaper, solution in mind. He proposes that supercomputers—like those at national laboratories such as Berkeley’s—should track every trade in real time. If volume began surging dangerously, the system would flash a “yellow light.” Regulators or stock exchanges could then slow trading down, giving the market time to clear and potentially averting a crisis.

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DCL: Perhaps it is time these people learnt a little about CEP?