New York: Widespread adoption of computerized trading has led to an increase in the number of electronic messages sent by traders to determine price quotes and volume, fuelling fears that an unusual surge in trading—the type brought on by an unexpected event—could paralyze the US market centres. An explosion in the use of algorithms, forecast to account for half of all equity trading by 2010, is raising concerns.
In algorithmic trading, computers carry out complex strategies, often according to shifts in market momentum. They automatically send messages to market centres to test prices and volume and then convey various buy, sell or cancel orders. For each order actually completed, algorithms may generate many times that number of messages or quotes. They are relayed between broker-dealers and market centres at lightning speed using computer protocol languages.
Quotes received by the NYSE Group, Inc., parent of the New York Stock Exchange (NYSE), averaged above 90 million per day in 2006, according to Aite Group. A decade ago, the daily average was less than 800,000.
“With algorithmic trading there is exponential growth in overall messaging volume,” said Sang Lee of financial services consultant Aite Group, LLC. “A lot of orders suddenly get cancelled as part of the strategy. That taxes the overall capacity of execution venues.”
Growth in messaging volume dwarfs that of actual trades. NYSE Group, now part of NYSE Euronext, receives about 20 times more messages than it did five years ago, while the amount of executed trades is about six times greater, according to Aite Group data.
NYSE and other marketplaces already experienced major delays when besieged by massive volume during a market slide earlier this year.
On 27 February, trades on the Big Board had to be executed after the official close as the S&P 500 experienced its biggest one-day drop in years, falling nearly 3.5%. NYSE has expanded its capabilities since the February delay, NYSE Euronext chief executive John Thain had said at the Reuters Exchanges and Trading Summit last month. But he could not rule out the Big Board or another exchange being paralyzed by message traffic. “We don’t get paid for messages, we get paid for trades,” Thain said. “So nobody has infinite message traffic capacity.”
Adam Sussman, of consultant The Tabb Group, says that if a market centre proves incapable of handling growing message traffic, another player will eventually take its place.
“I don’t see that as a risk to the overall market,” said Sussman. “I see that as a risk for less technologically nimble players within the market.”
Lee says the preponderance of algorithmic trading could exacerbate a market downturn. “Algorithms are built to look for anomalies.” Indeed, a problem in calculating the Dow Jones industrial average may have triggered a sharp rise in volume that led to the February delay, which took place after a sell-off in China precipitated the US market plunge.
Dan Mathisson, who heads advanced execution services at Credit Suisse Group, finds the fears unfounded. “Algorithms have been operating for a long time,” he said. “People who don’t like electronic trading have been waiting for years for something to happen. You can never prove there won’t be a problem but it’s not like there weren’t problems before.”
For individual, institutional or retail investors trying to get out of a position quickly during a market collapse, any disruption could mean they get a much worse price than they might have if it were running efficiently. Experts are divided about the gravity of the situation. Some argue that new demand will drive neededcapacity. REUTERS