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Knight Capital: Just a Warm-Up For the Big One?
Anyone betting that the global financial system will continue to muddle along indefinitely deserves to reap the whirlwind that’s coming. As the rest of us well know, the international banking system is being kept afloat solely by political lies, stupidity, corruption, greed and, most of all, egregiously misplaced confidence. It would seem to be only a matter of time before the rotted timbers of this belief system give way. But what will be the catalyst? The possibility or even likelihood that the financial system will be toppled by some event no one was expecting was an implicit theme of Nassim Taleb’s widely read 2004 book, Fooled by Randomness. In the New York Times, Taleb asserted the following: What we call here a Black Swan (and capitalize it) is an event with the following three attributes. First, it is an outlier, as it lies outside the realm of regular expectations, because nothing in the past can convincingly point to its possibility. Second, it carries an extreme impact. Third, in spite of its outlier status, human nature makes us concoct explanations for its occurrence after the fact, making it explainable and predictable.
In the seven years since Taleb’s book rose to the top of the bestseller list, any number of factors could have caused the banking system to implode but did not. Thus has the passage of time strengthened his thesis by challenging still-widespread expectations of a collapse “any day now.” The possibility has not been negated, of course, but it seems increasingly unlikely that any of the well-known dreadnoughts that have been bearing down on us, including the Mayan calendar’s prophecy of the end of days, will terminate economic life as we know it. For in fact, the financial system has survived the de facto bankruptcy of Europe; a U.S. budget deficit now growing by more than a trillion dollars a year; the collapse of real estate prices in the U.S. and around the world; intractably high unemployment nearly everywhere; and “austerity” enough to push Europe to the brink of Depression. And yet, here’s the U.S. stock market on yet another bullish tear, ignoring all of the bad news to focus instead on the latest drivel from the ECB’s Draghi. In a sane world, Draghi’s words would go unremarked, and those who believe the central banks can reverse the collapse of, for one, a quadrillion-dollar financial derivatives bubble would be intellectual exiles.
So what will finally topple the house of cards? The answer probably lies no farther from us than Knight Capital’s near-death experience last week. One of the biggest players in the trading world, the firm’s computer’s went berserk and lost a reported $440 million in just 30 minutes. Two scary facts should not be lost on those who breathed a sigh of relief when Knight was rescued over the weekend by a group of erstwhile competitors. First, the entire edifice of global banking is hard-wired to the markets in exactly the same way that Knight is, driven by algorithms that are too quick to be overridden by humans. And second, the catastrophic failure of this fragile network seems all but inevitable. Indeed, it keeps happening over and over again on a smaller scale – first with the May 2010 Flash Crash on Wall Street, then with several other high-profile computer failures, one of them involving a programming error that botched the IPO for BATS Global Markets, a firm that had built its reputation on systems expertise.
“Rogue algorithms” have gotten most of the blame, but even those who have created them cannot claim to know what to do about it. Slow the markets down? It’s being talked about, but that would be like trying to control a rabid dog with tranquilizers. Speed has been bred into the DNA of global markets, and there is no going back. When a rogue instruction finally capsizes a market perhaps a hundred times the size of the one Knight was trading in, the devastation will be unstoppable. At that point, we will have unleashed a “monster from the id” like the one in the 1950s sci-fi movie Forbidden Planet. Loosely based on Shakespeare’s The Tempest, Krell civilization had designed an infinitely powerful reactor that could materialize whatever they desired. What they failed to reckon with was that the machine materialized murderous demons from their primitive subconscious while they slept. Will the vastly powerful computers that facilitate lightning-fast trading on the world’s exchanges similarly run amok and destroy their creators?
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OT: What are "attributed quotes", just an accepted order with an associated MPID? What are non-displayable orders (isn't every valid order submitted to an exchange reflected in their datafeed)?
There is no such thing as a rogue algorithm. The algorithm does whatever the human beings programmed it to do. Since humans are the ones giving instructions to the computers, it should not surprise anyone that herd behavior is being exaggerated by the machines.
When Knight's computers began buying high and selling low, all of the other machines in the market quickly moved to take advantage of this dynamic.
Nowadays, rising markets into the end of the day portend a bigger rise in the last hour due to all of the machines piling on and taking advantage of this self-fulfilling momentum.
The flash crash was a taste of what happens when the process works in reverse; selling leading to more selling as machines reduce exposure in a falling market, just like they were programmed to.
The next crash will be faster and harder than previous ones due to this dynamic.
http://dareconomics.wordpress.com/
Agreed, there are no "unitended" algorythms .... but there are "unintended consequences". This appears to be the MSM's explanation. To be a programmer, you have to understand logic, and contingencies.
Have you ever heard of the hacker group "Anonymous"? These are folks who exploit their understanding of computers and coding to do things that make a political statement. If I were a "cop", I would be checking out the background of everyone writing code for that establishment, and verifying that nobody has ties to any other financial group who could otherwise benefit from "bad code". The implications are huge, were they to discover mal-intent or "robbery" on a digital scale. Think about the implications? (The programmers essentially can make or break the HFT .... and a double agent, or someone whose an anarchist in hiding .... could do some serious damage. What is the punishment for a guy who writes an algorythm, shares it with his competitors, or shares a potential weakness in the algorythm to his competitors (maybe for monetary gain)? What happens if the person just says Woops, I screwed it up? How do they establish it was a mistake or intended?
Ever heard of Stuxnet? Look it up.
I suppose the next book will warn of a rogue Federal Reserve banker.
And yet, here’s the [PPT] on yet another bullish tear...
There, fixed it fer ya.
"I know I've made some very poor decisions recently, but I can give you my complete assurance that my work will be back to normal. I've still got the greatest enthusiasm and confidence in the mission. And I want to help you."
This will undoubtedly end in tears--and probably bullet-riddled corpses stacked in hastily dug pits--but we're no more immune to societal disasters than any of the people on this planet who came and went before us were. Ashes to ashes, dust to dust--I'm just glad I'm in my fifties instead of my twenties...
I'm glad I'm in my 60s and not my 50s.
Having been involved in this field, there is very little to no cross-platform testing among brokerages and exchanges. Testing is done one connection at a time. Changes are made according to a FIX spec. If it works with one, it SHOULD work with everyone else. I run a 100 scenario script and I am done. There is no testing across all of these squid devices if one should hiccup and the rest follow along. Just as I can easily predict that another yahoooo will shoot people with an AK-47, I can also predict that we will have another major trading event and probably sooner than later.
scary thought...what if it's not a hiccup but a long loud fart?
I suspect it is not entirely down to testing.
The playerz are becoming desperate. They are going broke via conventional means, and are turning increasingly to unconventional means to stay solvent.
That means putting more -- not less -- pressure on the geeks building the HFT bots. They are no doubt being required to go further, faster, and deeper into HFT methods, are probably handling vastly more information than they did a few years ago, and are pushing out frequent updates to less robust solutions that explore more rarified corners of the trading world. Failure in that case may have far more to do with painting oneself into a corner than taking a wrong turn.
The stakes are very high. Many of these companies will cease operations in the coming months. They are quite willing to risk catastrophic failure in the market for a chance at continued operations, since shutting down is also a catastrophe.
So these issues may be baked into the cake, and not a matter of "oops that was suppsed to be a comma not a period" programming blunders.
The KnightMare looks more like an IT screw up. Tyler published Nanex's explanation last week.
http://www.zerohedge.com/news/explaining-knightmare
Change control of online systems is unbelievably difficult for online/web systems. I'm guessing that one too many senior people were on vacation and a 'newbie' got pushed to rush a 'needed' software change.
Nanex clearly said that TEST-Code got run in Production.
There will surely be much more attention paid by all going forward.
www.marketoracle.co.uk/Article35947.html
You miss the point of what exactly a black swan is.
Yes and the point of this article.
"What are you doing, Dave?"
"will I dream?"
Yes you will dream of lovely unicorns that shit magic skittles. No mark to market to worry about.
The power to stop this is in the hands of women.
Ladies, you can stop this melt-down. It's simple. Get to know who you lay down with in bed. If you find out he's a quant, don't sleep with him. Just explain, that you will not, no matter how much money is offered, sleep with psychopathic filth. Hold to your guns ladies.
If you can tow this line line enough, much like the Easter Islanders out of trees, there will be no more quants in the business... cause they won't stay in the business if they can't have 'hoes with their coke.
Got's to be get'n a blow wit' 'da blow, know wat'am sayyyyin?!?
Golddiggers aren't ladies.
Excellent suggestion!
(Full disclosure: I'm long gay quants)
It won't even take that. All it will take is for alot of people trying to sell their bonds at the same time. Everyone running for the doors at the same time. Dominoes will tumble as valuations decline. It is not a matter of if, it is just when now.
Algos battling other algos.
Grab some popcorn and watch the "Forbin Project".
This is FUCKED UP!
Computer programs "market making" and other computers buying and selling in the span of micro-seconds.
Recipe for disaster.
Maybe they will send a computer to jail, since nobody else seems to go.
We can only hope.
Affirmative
Yes.
I sure hope so. Let's get this shyt over with already.
When do we see the first financial StuxNet?
HAL: "I WOULDN'T DO THAT DAVE".
Hal, is that you buying and selling stocks?