If it was a trading error> that triggered Thursday s unprecedented market selloff, this wouldn t be the first time a small mistake had big consequences for investors.
As long as companies have been publicly traded, practical mistakes have wound up devaluing stocks or sending the broader indexes plummeting. More recently, the rise of electronic trading has accelerated or exaggerated the effect.
Thursday s fall was unique. Analysts say that there is no precedent for the market conditions leading up to the selloff.
What occurred yesterday happened during a period of intense volatility as people were trying to figure out what impact the crisis in Greece would have on global markets, says Andrew Barber, strategist at Waverly Advisors, an asset management firm in Corning, N.Y. Then you introduce this other element of an error and suddenly you have a market rout.
At least one common practice of modern trading played a role. Today, many retail investors leave orders with their broker to buy or sell a stock once it hits a certain price. Those orders ensure that many big swings automatically grow bigger.
Most major trading errors have occurred in the past 15 years, as electronic trading became more common across exchanges and institutional investing firms. Although automation has reduced the number of human errors that used to occur as a customer s order traveled from a broker to the floor, electronic trading has created a more systemic risk. Fewer errors may occur, but they may weigh heavier on the market.
Computerized trading strategies are designed to stabilize the market by automatically buying when stocks dip and selling when they rise, says James Angel, an associate professor of finance at Georgetown University s McDonough School of Business. However, in certain circumstances, those systems can make a bad situation worse, he says.
These systems are especially prone to errors when a trader or broker monitoring them isn t paying close attention, says Tim Shirata, director of operations at Guild Investment Management, an investment advisor. A common example is the so-called fat finger error, in which a trader intending to press m for million hits b instead.
Several protections are in place to safeguard investors from market swings that result from errors. Most major exchanges have circuit breakers, which are designed to halt trading after a given index drops by a substantial amount.
The New York Stock Exchange (NYSE), for example, created its circuit breakers after the crash of October 1987. If the Dow Jones Industrial Average drops by 1,050 points before 2 p.m., trading will stop for an hour. If the drop occurs between 2 p.m. and 2:30 p.m., the halt lasts for half an hour. And if the drop occurs after 2:30 p.m, there is no halt.. However, if there is a 2,150-point decline after 2 p.m., it will trigger a circuit breaker. In that case, the exchange will close for the rest of the day.
The NYSE also has a system that can temporarily slow a market cascade by stopping electronic trading and requiring human intervention. However, the system has limitations, Angel says. Because the exchange handles only about a fifth of the trading in New York-listed stocks, a slowdown at the NYSE would not prevent a broader disaster.
Another safeguard is the simple ability to nullify trades. Most major U.S. exchanges have announced that they plan to cancel most trades executed Thursday between 2:40 p.m. and 3 p.m. that were 60% higher or lower than the last price before the drop.
Here's a look back at five trading errors that impacted the markets.
Bear Stearns hits B
Oct. 2, 2002
In what appeared to be a fat finger error, a Bear Stearns trader who intended to place a sell for $4 million placed an order for $4 billion instead. The erroneous trade occurred at 3:40 p.m., sending U.S. markets into a tailspin on a day when stocks had been trading lower. The Dow fell by 183 points to hit a day low of 7697 before recovering a bit and closing at 7756.
Mizuho s wrong number
Dec. 8, 2005
A trainee at Mizuho Securities in Japan intended to place a commissioned order to sell one share of J-COM, a recruitment and placement company in Osaka, for 610,000 yen on the Tokyo Exchange. Instead he placed an order to sell 610,000 shares at one yen each. Shares prices of J-COM plunged along with the Nikkei, which closed down 287 points at 15183, a 1.9% drop. Mizuho lost about 41 billion yen ($338.9 billion in 2005).
In January 2006, Mizuho announced that it was in the process of implementing measures to keep such an error from occurring again, including separating the sales function and the system entry for execution of orders; tightening the rules regarding the placement of orders for initial public offering shares; and monitoring the placement of abnormal orders for IPO shares in real time, particularly before the placement of large orders.
A mystery in biotech
April 28, 2009
An apparent trading error sparked a selloff in shares of Dendreon (DNDN),
Lehman adds two zeros
May 14, 2001
A Lehman Brothers trader accidentally typed 300 million instead of 3 million when trying to sell a group of stocks in London. Because the mistake happened at the end of the British trading day, a lack of liquidity helped to drag the FTSE index down 130 points, or 2.2%, in just a few minutes.
Salomon elbow goes astray
July 23, 1998
A Salomon Brothers trader leaned his elbow on his keyboard, setting off an instant sell keyboard command and accidentally repeating a sale he d just made on Matif, the French futures exchange market, 145 times. The result: a 1.4% drop in the price of France s 10-year bond.