Wall St. trading glitch exposes flaws in electronic trading

A technical glitch on the stock market caused sharp swings in dozens of stocks early Wednesday, causing confusion and disarray in the first hour of trading.

It was the latest breakdown in the increasingly complicated electronic systems that run stock trading, which have been showing signs of strain as more traders and big investment firms use powerful computers to carry out trades in mere fractions of a second.

Coming less than three months after a snafu tarnished the debut of Facebook, the latest bug on Wall Street threatens to further erode investors' confidence in U.S. financial markets, experts say.

"This is a black eye," said Sal Arnuk, co-founder of Themis Trading and co-author of "Broken Markets." ''The plumbing in the system is faulty and is wreaking havoc on investors' confidence."

The problems began when dozens of stocks started moving up and down by wide margins for no apparent reason. Abercrombie & Fitch jumped 9 percent within minutes, hitting $36.75 after closing the night before at $33.80. Harley-Davidson suddenly fell 12 percent, to $37.84 from $43.23. Wizzard Software shot up above $14 after closing the night before at $3.50, according to data compiled by FactSet.

The culprit was Knight Capital Group. Knight, which takes stock trading orders from big investors and routes them to exchanges, said in a statement that a "technology issue" had occurred that affected the routing of about 140 stocks to the New York Stock Exchange. Later in the day, NYSE said it was canceling faulty trades in six smaller stocks, including Wizzard.

Knight told its clients to send their orders away from its system and said it was reviewing the issue. The episode was an embarrassment for Knight's CEO Thomas Joyce, who was one of the biggest critics of the Nasdaq stock market for the way it handled Facebook's initial public offering.

Knight's own stock plunged $3.39, or 33 percent, to $6.94 on Wednesday.

The trading problems served as a reminder of other miscues that have shaken investors' faith in recent months:

— Facebook's highly anticipated first day of trading on May 18 was thrown into chaos because of computer glitches at Nasdaq. The opening was delayed by half an hour. Many investors couldn't buy shares in the morning, sell them later in the day, or even know whether their orders went through. Nasdaq is preparing to pay as much as $62 million to firms that were hurt from the glitch.

— In March, an electronic stock exchange called BATS Global Markets Inc. had to cancel its own initial public offering after a series of technical snafus prevented its stock from ever opening for trading. The CEO of the Kansas City-based company, Joe Ratterman, gave up his role as chairman and issued a public apology.

— In May 2010, the Dow Jones industrial average dropped nearly 600 points in five minutes because of technical problems, an even that was dubbed the "flash crash."

"I don't know why such glitches are acceptable," said Eric Hunsader, CEO of Nanex, which provides data on stocks.

Though Knight didn't provide details on what happened, much of these glitches stem from issues related to the computers and algorithms that power the world of high-frequency trading, where millions of trades are conducted in nanoseconds. Most of the volume of stock trading comes from such computers. Because machines conduct these trades, the propensity of malfunctions is high, since humans can't put a stop to these trades until it is too late, or the damage is already done.

Such glitches can hurt investors, especially those that may have had placed automatic orders with their brokers to sell stocks that hit a certain price.

The Securities and Exchange Commission was involved in the looking into the matter throughout the day, spokesman Kevin Callahan said in a statement. "As is our practice, we are closely monitoring the situation and in continuous contact with the NYSE and other market participants," Callahan said.

People like Hunsader, Arnuk and others have been calling for better oversight of practices that lead to such glitches.

"High-frequency trading, the idea that computers and algorithms are trading very rapidly in the marketplace and putting pressure on the system, absolutely is something that ultimately needs to be addressed," said Matthew Rubin, director of investment strategy at Neuberger Berman.

The disruptions occurred, ironically, on the same day that the Securities & Exchange Commission published a final rule aimed at preventing trading disruptions like the May 2010 "flash crash." The new rule establishes a single, consolidated record of all the trades on a given day.

Arnuk wondered why the public companies tolerate such market movements that hurt the prices of their stocks.

"It's time to stop punting and enact regulation that restores confidence in the markets," said Arnuk.