Did Shutdowns Make Plunge Worse?

A number of high-frequency firms stopped trading Thursday in the midst of the market plunge, possibly adding to the market’s unprecedented selloff.

Tradebot Systems Inc., a large high-frequency firm based in Kansas City, Mo., closed down its computer trading systems when the Dow Jones Industrial Average had dropped about 500 points, said Dave Cummings, founder and chairman of the firm.

Tradeworx Inc., a N.J. firm that operates a high-frequency fund, also stopped trading during the market turmoil, according to a person familiar with the firm.

Mr. Cummings said Tradebot’s system is designed to stop trading when the market becomes too volatile, too fast.

‘That’s what we do for safety,’ he said. ‘If the market’s weird, we don’t want to compound the problem.’

Tradebot says it often accounts for about 5% of U.S. stock-market trading volume.

The withdrawal of high-frequency firms from the market didn’t necessarily cause the downturn, but could have added to it, some market experts say.

A number of high-frequency firms closing down in the midst of a sharp market drop can ‘widen markets out substantially,’ said Jamie Selway, managing director of New York broker White Cap Trading.

High-frequency firms have in recent years become central to how the market operates, growing to account for about two-thirds of daily market volume, according to industry estimates.

The firms use high-powered computers to send ‘buy’ and ‘sell’ orders to the market at rapid speeds. High-frequency traders have said part of the value they add to markets is the liquidity they bring — being at the ready to swiftly complete a trade. Some of these firms have said that, were it not for them, the 2008 market declines would have been worse.

Thursday’s downdraft suggests how important that liquidity-providing role has become. Market participants say some high-frequency firms pulled back as the speed and extent of the decline went outside their models, which are generally based on the market behaving in a normal fashion. To avoid the risk of big losses, the firms essentially turned off their trading programs.

That appeared to leave investors with fewer traders to take the other side of their orders.

‘We did see several clients who stopped trading,’ said a broker who caters to high-frequency firms.

Some high-frequency traders, including Mr. Cummings at Tradebot, say their moves didn’t accelerate declines. He says other firms selling large positions caused the market turmoil and that Tradebot would have been risking losses if it had continued trading. He says exchanges need to install better systems that automatically stop or slow trading when the market becomes overly chaotic.
‘The design of the market should halt [trading], and there should be an orderly reopening,’ he said.

Exchanges such as the New York Stock Exchange, operated by NYSE Euronext, have circuit breakers that can halt trading over the broader market in steep declines, but they weren’t triggered Thursday.

Technical factors that high-frequency firms and other quantitative funds use to trade likely also played a part as the selling accelerated.

When the market hits certain levels as it falls, these firms’ computers are programmed to sell automatically as protection against further losses.
‘This was a massive liquidation panic,’ said Bill Strazzullo, chief market strategist for Bell Curve Trading, a Freehold, N.J., technical-research firm.
As the losses accelerated, there were little to no ‘buy’ orders left in many stocks and other assets, causing a plunge that saw some securities spiral to near zero. ‘You just blew through everything,’ he said.

Scott Patterson