An interesting article on Bloomberg today illustrates the vicious circle that algorithmic and HFT  may be leading us down.

Computers cause trading errors.  Regulators react to trading errors with new reforms. Those same new reforms exasperate the next computer trading error.

Rules formalizing the treatment of erroneous trades were adopted amid criticism by investors after exchanges and the Financial Industry Regulatory Authority voided transactions totaling 5.6 million shares on May 6, 2010. Regulators added guidelines governing when sales or purchases of stock could be canceled after market makers said confusion about which trades would stand prevented them from acting during the rout.

The rules had their biggest effect earlier this month after Knight’s unintended orders caused volume suddenly to surge and prices to swing in dozens of securities just after trading began. Executives at the New York Stock Exchange canceled transactions that were 30 percent or more away from their price at the start of trading, a decision that applied to six securities out of 140 that were reviewed.

My guess is that after the “flash crash” the methodology for cancelling trades was probably highly slanted towards helping institutional investors instead of retail ones, which prompted an outcry and forced a more fixed set of “rules” for cancelling these types of trades.

This time however, it looks like those rules actually punished the right people.

Knight $440 Million Loss Sealed By Rules On Canceling Trades (Bloomberg)

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