Electronic trading continue to hit markets
Issues with electronic trading continue to hit markets
The stock market crash of 1987 gave London's financial institutions a hard lesson in the issues of electronic trading. Twenty years later, electronic trading has become much more sophisticated, but risks remain.
Program trades caused domino effect
Luke Jeffs
16 Oct 2007
The Big Bang and greater use of computers contributed to the crisis
The 1987 stock market crash may have exposed City of London institutions to the perils of electronic trading for the first time but 20 years on, the risks remain.
The events of Black Monday, the day the London Stock Exchange lost a quarter of its value in a single trading session, can be traced back one year to Big Bang.
The deregulation of the LSE, and the move away from the exchange’s traditional open outcry trading floors to computer screens was an important step for the exchange as it sought to establish itself as an international financial center.
Electronic trading, which made executing orders cheaper and more efficient, proved an immediate hit with the new breed of technologically competent brokers, and volumes rose.
By October the following year, the surging stock market was encouraging more retail exposure to shares, but institutional investors were using new program trading techniques to arbitrage markets and insure themselves against a market correction. When the correction came, it was the dormant electronic trades that had previously not been activated that started automatically selling stock which, in turn, triggered more program trades, exaggerating the stock market crash.
Terri Humphreys, head of market activities at Baring Asset Management, said: “The crash resulted from a combination of factors. At the time we weren’t used to trading electronically and the markets were more transparent, meaning once it started it quickly escalated.”
The situation was compounded by a hurricane the previous day, meaning that many traders had been unable to get into the office and unwind their positions that day.
The crash brought home to traders and institutions for the first time that trading on the stock market could be dangerous, Humphreys said.
She said: “The crash made us more aware of the risk of trading in the electronic marketplace. The fact that we were using systems definitely contributed to the extent of the losses, whereas if we’d been trading the old-fashioned way, using open outcry, the losses would have been smaller.”
Electronic trading has come a long way since Black Monday and traders use more sophisticated hedging techniques than those popular in 1987.
Yet the risks inherent in trading electronically can be seen in today’s markets, most recently in August when algorithmic trading was blamed for extreme volatility.
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posted by Victor Lloyd Smith @ 1:31 PM
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