Akst: Knight Capital lives and dies by computerized trading

On Wall Street, as elsewhere, he who lives by the sword dies by the sword.

The latest proof of this adage comes to us from a firm called Knight Capital, which managed to lose $440 million in less than an hour as a result of some poorly tested software. Can anyone really doubt that the digital revolution has boosted workplace productivity?

The fear is that, thanks to advances in software and computing power, Wall Street firms will someday be able to lose billions in mere seconds with no human intervention whatsoever. But leave aside for now the impressive leaps in financial automation that might be ahead.

What's interesting in this case is that Knight's bread and butter was superfast trading: using computers to execute a gigantic volume of buy and sell orders per second, thereby exploiting small variations in share prices.

These high-frequency traders are a big deal nowadays. They make up more than half the activity on U.S. stock exchanges; Knight by itself accounted for something like 11 percent, and is therefore no mere pawn in the controversy over such trading.

So the very thing that made Knight successful has proved its undoing. And while critics of high-frequency trading have called for limits on the practice, the industry has predictably opposed them, claiming its members are doing investors a world of good by increasing liquidity in the markets.

Of course, liquidity is of little use to the drowning. Stock trading once confined to a couple of major exchanges today occurs in a variety of arenas, some of them not even official exchanges, and the whole process has fallen captive to the dangerous technology that was supposed to improve it.

Market disruptions, often involving computers, have become commonplace. A computer glitch sent stocks plunging in the "flash crash" of 2010. Earlier this year, in an episode that would be delicious if it weren't so pathetic, an outfit called BATS Global Markets -- a leading electronic stock exchange -- couldn't complete its own initial public stock offering because of technical problems.

Knight says none of its customers suffered from its little computer hiccup, but the firm's rapid buying and selling during 45 minutes on Wednesday roiled markets and shook the firm. And it's one more chink in the battered armor of its industry. Knight's tumble comes after the collapse of MF Global, a commodities trading firm that somehow mislaid $1.6 billion in customer funds, and the Ponzi scheme run by Bernie Madoff.

It almost goes without saying that such developments undermine public faith in equities, which is bad for everybody. Historically, a diversified stock portfolio has been a good vehicle for carrying savers to retirement. And if people won't invest in stocks, companies will find it harder to raise the capital to grow, hire and innovate. Turning people off to stocks, in other words, can make all of us poorer.

The investment world has always had its share of collapses and cons. And the plunge of stocks in the 2008 financial crisis has already scared some people off. Better regulation might have averted the financial crisis, and should have uncovered Madoff's scheme.

But technology is something else again. The prospect of a future dominated by runaway computers makes investors feel like the astronauts in "2001: a Space Odyssey," hurtling through the blackness aboard a vessel controlled by the malevolent computer HAL. Is it any wonder a lot of people would prefer not to get aboard?

We'll never pull the plug on HAL. But it's high time somebody reminded him who's boss.

Daniel Akst is a member of the Newsday editorial board.