Firms are being warned that they should be keeping their algos in check so that trading debacles, such as the recent Knight Capital software glitch, can be kept under control.
Most market participants now use some form of algorithm to either execute their orders or pursue an investment strategy—with some estimates saying that algorithmic trading now accounts for around three-quarters of all stock trades in the U.S.—and with algos expected to be used more widely in over-the-counter markets in the near future, compliance departments are being left with their work cut out just to keep up with the monitoring of trades at ever faster speeds.
“If you had a real time view of unrealized profit and loss, you immediately see when an algo is slipping away from you,” Matthew Coupe, sales director of Redkite Financial Markets, a provider of real-time market surveillance systems, told Markets Media.
“The big question is when do you respond to make sure that you shut it off and interfere with your algo. If you had appropriate at-trade real time risk on that you would be able to understand what is going on.”
Coupe says that there are a few classic traits for spotting when an algo begins to run amok. These include a repetition of orders, which, Coupe says, “is a classic example when an algo gets stuck into a stream”. Excessive cancels is another, while with in-depth behavioral analytics you can begin to understand when an algo “becomes more aggressive and starts creating a sort of artificial volatility in the markets”.
Being able to understand all of this in real time is key, though, and having the tools at hand to immediately make a judgement before “pressing the red button to stop the rogue algo in its tracks”, said Coupe.
U.S. market maker Knight Capital was left close to bankruptcy last month following an algorithmic error that caused erratic trading activity and left the firm with billions of dollars of unwanted securities. The company estimated that it lost $440 million because of the software glitch. In this case, the faulty algorithm was left unchecked for a part of August 1, the day Knight’s faulty software acquired large volumes of shares at unfavorable prices, before Knight realized the error and was then forced to sell the shares—as the market had moved against the market-maker—later in the same day to reduce further losses.
One principal trading firm and options market maker, Tibra, has recently announced that it has selected Redkite to ensure compliance monitoring.
The move is also aimed at bringing Tibra into line with the new rules set out by the European Securities and Markets Authority (Esma) on automated trading governing algorithmic trading practices in Europe. Esma has taken the lead in this field compared to other regulators around the world, who are only now waking up to the dangers of rogue algos.
"Tibra is committed to industry best practice in all trading operations including compliance,” said Denis Jackson, regional general manager of Europe for Tibra, which operates in multiple markets across Australia, Asia, Europe and North America.”
Coupe at Redkite added: "Principal trading firms such as Tibra now have the requirement for intelligent and efficient market surveillance tools. To this end, Redkite Financial Markets has turned algorithmic trading scenarios on their heads with a solution that reaches out and detects trading anomalies and potentially abusive trading practices in real-time, in the most accurate manner. We are delighted Tibra has selected the Redkite Surveillance compliance monitoring solution.”
Another firm to offer market surveillance solutions to deal with the new Esma rules is trading and technology firm SunGard, through its Protegent Market Abuse solution.
SunGard’s system offers analytical tools such as graphical visualizations of market events, news and market data. It also provides a configurable baseline rules and reports library, helping ensure compliance with the Esma regulations and also the European Union’s Market Abuse Directive, as well as the relevant parts of MiFID, which governs the conduct of financial services firms in Europe.
“It’s crucial that trading participants establish a comprehensive trade monitoring process in order to comply with all of the regulatory requirements, minimize the regulatory risk involved in trading activities and protect their reputation,” said Steve Sabin, chief operating officer of SunGard’s Protegent business unit.
Davy, an Irish stockbroker, has selected SunGard’s Protegent Market Abuse to help identify high-risk behaviors across its equity and bond trading operations globally.
“It is vital to display corporate responsibility and identify potential market abuse,” said Ger Knowles, head of regulations and compliance at Davy. “SunGard’s Protegent Market Abuse solution provides the flexibility and functionality that we need to help manage the increasing regulatory requirements to perform timely and exhaustive market abuse surveillance.”
