Buy-side should protect itself from tech problems

Regulators might be keen to crack down on computer problems on exchanges, but the complexity of technology means there may never be a problem free market.

By None

What is causing all these glitches?

The cause of the problems experienced by exchanges varies considerably. A closer examination of the circumstances that hit Nasdaq in August and took the exchange down for three hours reveals that the problem was related to a server being overloaded with too many requests.

Regulators, market participants and the public should remember that all technology has a finite capacity. Many of the cyber security threats faced by banks and others are dependent on servers having a design limit, as they will overload a computer with thousands of requests a second in order to bring it down. It’s the same for exchange hardware, which is designed to tolerate a certain number of requests, usually well above what is commonly seen in the market, but exceptional or unusual circumstances can cause this to suddenly increase rapidly.

Other problems can be more mundane, caused by a power outage, human error, connectivity problems and more. Ultimately, there are so many ways an exchange could go down, that you could well say it’s surprising exchanges are able to operate smoothly most days.

Can these problems ever be solved?

If we assume that technology is helping to drive the speed of trading, then we can expect markets are going to continue to get faster for some time. While exchanges are continually upgrading their technology, it can be hard to keep up with the latest high-frequency trading trends. 

Similarly, resources are finite. Exchanges are already under pressure to diversify their business because of lower trading volumes since the financial crisis. There is only so much that can be spent on technology, and implementing extremely high levels of redundancy in systems would be very expensive.

How can I protect myself?

If we accept that exchange glitches and rogue algorithms are going to happen then it’s ultimately up to the buy-side to protect themselves. Asset managers should be doing a lot of due diligence on algorithm providers to make sure they’re only using thoroughly vetted algorithms.

Setting risk limits on electronic trading activity is one way to avoid the worst technological glitches the market can throw at you. A risk limit would trigger when any given stock or stocks that you’re trading suddenly go outside of their usual range. In this way, even if an exchange circuit-breaker fails, or is incorrectly calibrated, your algorithm will have already stopped trading automatically. 

The other factor is to simply be aware that these problems can happen and be ready to trade elsewhere. If one exchange goes down and a trader needs to make an urgent trade, then having connectivity to another venue trading the same stock can be invaluable.