Recently, I started to be interested in financial markets catastrophic mistakes produced by humans or determined by algorithms.
On 2001, a trader of UBS Warburg meant to sell 16 shares of a company at 600,000 yen. Instead, he submitted an order for selling 610,000 shares at 6 causing a catastrophic failure with an estimated cost of 100 million of dollars. This is just the start, since things become more and more interesting when machine learning algorithms and artificial intelligence are used. ML and AI can turn a catastrophic failure into an epochal failure.
On 1987, October 17 a new algorithmic mechanism for automatic selling shares below a certain ground price has been put in production. October 17 was Monday and the new system introduced an un-expected latency which left some un-processed orders from the past week in the back-log queue. Guess what happened when all of them were processed all together? The price dropped instantaneously and the automatic mechanism for selling had an huge amplification effect. October 17, 1987 become a Black Monday with a 22% of loss in one single day, the worst day since 1929.
Today, we live in the Flash trade epoch. Humans are buying stocks aiming at keeping them for days, weeks, month or years. Flash trading algorithms have a different approach. The idea is to buy a stock and selling it after few micro-seconds. Talking about fast processing and investing on a long term basis. You don't care about what happens in two hours, you just try to predict what happens in a couple of micro-second away. Note that those algorithms can sometime see orders before they are processed, and this can probably make the prediction easier. Flash trading is taking about 25% of London Stock Exchange transactions.
A couple of weeks ago, US authorities published a report saying that on May 6 2010 the market suddenly dropped of 10% generating 1 trillion $ of loss (that is 1000 billions, wow!). Why? a single mistake! One order of selling 4.1 billion dollars linked to a future contract and submitted by a Kansans medium-size firm was accepted with no lower bound selling price limit, by mistake.
No one bought the contract and all the flash trading algorithms started to sell all the stocks all together in an amazing amplifying effect.
Did i say that I love Machine learning and Artificial intelligence?