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Swings in US stocks spur computer trade concerns

Aug. 1 (Bloomberg) -- Knight Capital Group Inc. told some clients of its market-making unit that a “technical issue” was affecting its systems and advised them to route orders elsewhere as dozens of U.S. stocks swung more than 10 percent today.

Knight, which helps execute billions of dollars in equity transactions every day, said the issue was confined to market making and other operations were unaffected. Its stock plunged as much as 26 percent as investors speculated on its role in the incident, which spurred concern that computers had distorted trading for the second time in two weeks.

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The incident, occurring after three Dow Jones Industrial Average stocks fluctuated in regular hourly patterns for a full trading day on July 19, may embolden critics of American market structure who say the computers that dominate trading have become too complex to control. Special curbs adopted after the May 2010 equity crash helped calm today’s volatility.

“All of a sudden, there was choppy trading and some stocks were halted,” Arthur Hogan, a strategist at Lazard Capital Markets LLC, said in a telephone interview. “People were scratching their heads, but it wasn’t a sense of panic. It was more curious. There’s got to be some human error here.”

Goodyear Tire & Rubber Co. rose more than 10 percent just after the 9:30 a.m. open in New York. Manitowoc Co. gained 14 percent, Pandora Media Inc. climbed almost 11 percent and Level 3 Communications Inc. plunged 15 percent before the swings narrowed minutes later, according to data compiled by Bloomberg.

Internal Review

“An initial review by Knight indicates that a technology issue occurred in the company’s market-making unit related to the routing of shares of approximately 150 stocks to the NYSE,” according to a Knight e-mail from spokeswoman Kara Fitzsimmons.

“Knight notified its market-making clients this morning to route listed orders away,” according to the statement. “The company’s OTC securities and trading in its other businesses are not affected. The company continues to review internally.”

Knight’s market-making business traded a daily average of $19.5 billion worth of equities in June with volume of 3.1 billion shares, according to the company’s website.

The New York Stock Exchange said it was reviewing trades in 148 securities between 9:30 a.m. and 10:15 a.m. New York time, according to a statement on its website.

“At this time, we believe NYSE systems and circuit breakers operated normally during this period, and we are working with all market participants on the issue,” NYSE said in an e-mailed statement.

Robert Madden, a spokesman for Nasdaq OMX Group Inc., declined to comment.

‘Closely Monitoring’

“As is our practice, we are closely monitoring the situation and in continuous contact with the NYSE and other market participants,” Kevin Callahan, a spokesman for the Securities and Exchange Commission in Washington, said in an e- mail.

NYSE employees took steps to stabilize individual stocks when unusual patterns materialized, Jason Weisberg, head of institutional trading for Seaport Securities Corp., said in a telephone interview from the exchange.

“Things were always calm,” Weisberg said. “When the price dislocations were popping up all over the room, exchange officials picked up on the anomalies and put the brakes on. It was happening so frequently and simultaneously they didn’t catch everything, but they caught most very fast.”

Trading was halted on at least six stocks on the NYSE after they tripped so-called “circuit breakers” designed to prevent surges and plunges linked to unusual trading. China Cord Blood Corp. soared more than 150 percent; CoreLogic Inc. fell more than 11 percent; Trinity Industries Inc. rose 17 percent; Kronos Worldwide Inc. climbed 19 percent; and Molycorp Inc. fell almost 18 percent.

Increased Scrutiny

Investors in three of the biggest Dow stocks witnessed repeating fluctuations on July 19, fueling speculation the moves were a consequence of computerized trading. Shares of International Business Machines Corp., McDonald’s Corp. and Coca-Cola Co. swung between successive lows and highs in intervals that began near the top and bottom of each hour.

Regulators have increased scrutiny of computerized strategies that rose to prominence in the U.S. after more than a decade of market structure reform. The Securities and Exchange Commission and Commodity Futures Trading Commission blamed a broker’s algorithm for setting into motion the events that caused the May 6, 2010, market crash that briefly erased $862 billion from U.S. equities in less than 20 minutes.

VWAP Algo

Algorithms are automated trading strategies that can be used to break larger buy or sell orders into smaller pieces over a specified period of time such as an hour or day. Traders at fund managers or brokers use them to mute price impact and mask their activity as they try to scoop up visible and hidden orders spread across exchanges and alternative venues such as dark pools and provide bids and offers to other investors.

A volume-weighted average price, or VWAP, strategy seeks to buy or sell stock over a certain period, weighted for the number of shares traded at different levels. A percentage-of-volume algorithm will try to account for a specified share of trading volume in a company’s stock to avoid buying or selling that moves the stock price. More aggressive and tailored algorithms exist to fine-tune trading based on market conditions such as changes in volume, volatility or the price movements of indexes.

Today’s trading is “yet another example of how the market structure plumbing is responsible for massive price distortions,” Joseph Saluzzi, co-head of equity trading at Themis Trading LLC in Chatham, New Jersey, said in an e-mail. “August 1st will be another day that will destroy investor confidence just like the May 6th flash crash” of 2010.

Audit Trail

The SEC voted last month to require exchanges and the Financial Industry Regulatory Authority to build a single system to monitor and analyze trading activity on U.S. equity and options markets. The rule mandates a so-called consolidated audit trail to expedite surveillance across 13 equity exchanges, 10 options markets and more than 200 broker-dealers that execute stock trades away from public venues.

The effort is part of the agency’s response to the May 6, 2010, stock rout that temporarily sent the Dow down almost 1,000 points. The so-called flash crash was triggered by a mutual fund firm’s algorithmic trade that sparked the rapid selling of financial futures because it took into account volume but not price or time, according to a report released by the SEC and CFTC in October 2010.

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