Computer code, high-speed trading firm, & losses
Published on: 15 December 2024
9:30 am, 1 Aug 2012.
Immediately after the markets opened, traders knew something was wrong.
The volume of trades seemed abnormally high.
Too many orders were being placed, but no one knew who was placing them.
The order volume was large enough that some stocks’ prices started getting pushed up.
Traders wondered why it had not stopped.
In the world of high-speed trading, even 1 minute is an incredibly long time.
And yet these orders kept coming in.
Knight Capital
Knight Capital was one of the largest traders in the USA back in 2012.
They had a market share of around 17% on the New York Stock Exchange (NYSE) and NASDAQ.
They offered services in areas like high-speed trading, electronic execution, institutional sales, etc.
On any given day, they would trade around $21 billion worth of shares!
In July 2012, the exchange made some changes to the rules.
This required Knight Capital to change its computer’s code.
The way their code worked was that it received a large order (parent order).
Their computers or servers would then break this large order into smaller orders (child orders).
These child orders would be placed on the exchanges.
This code needed a small update – because of the new regulations.
The new code was written and tested by engineers. Everything worked as expected.
By 31 July 2012, the engineers started putting this code onto their servers.
They had a total of 8 servers.
But they made an error.
The new code was put on 7 out of the 8 servers.
One server had the older code.
1 Aug 2012
In a server room, engineers working at Knight Capital realized that their computer was placing large orders – orders that they did not want to place.
Over the next 20 minutes or so, the engineers fished through the new code looking for the error.
They did not find any errors.
The orders were still getting placed.
They kept looking for the error for another few minutes.
Unable to find the error, they made a conclusive decision – whatever the error was, it started after the new code was put on the server.
So, the error must be in the new code.
They also realized that the new code was on 7 out of the 8 servers.
They decided to remove the new code from the 7 servers.
They did it.
And the orders – they still kept getting placed!
The engineers were shocked. They panicked even more.
Crucial minutes were going by. The solution was not in sight.
45 minutes after the error started, they decided to completely stop all their servers.
Finally, the orders stopped getting placed.
In these 45 minutes, Knight Capital’s servers had placed more than 4 million orders.
In the few minutes that the servers placed orders by mistake, the volume of stocks traded had shot up to double the normal values.
It increased volatility and made many investors cautious and nervous.
If there had been other factors involved in the market at that time, it could have also triggered a chain reaction – of traders and investors going on a selling spree.
What Happened?
Eventually, they found the mistake.
The problem was not with the new code. The new code had been tested and re-tested well.
The problem actually lay inside the older code.
There was an unused part of the older code — that part had been used many years ago.
The old unused code got activated due to some signals (also called flags).
When this code got activated, it started placing child orders without a limit.
This is why stopping the 7 servers with the new code did not stop the problem.
In fact, had they ensured that the new code was correctly put on all 8 servers, this error would not have taken place.
After this episode, new regulations were brought in by the US regulators to ensure such mistakes are not repeated.
End
As for Knight Capital, things were not good.
Immediately after placing orders, the company had to pay for them.
They did not have the money to pay for these orders.
Desperately, they tried to raise the capital. They managed to get funding from a group of investors.
Net, they suffered a loss of around $400 million.
A few months later in December 2012, they were acquired by another company – Getco LLC.
This episode is another reminder to us investors — that in the computer age where billions worth of stocks can be traded in seconds, even a tiny error can cause massive market movements.
This was not the first time or the last time computers scared traders and investors.
And it is likely that we will see similar days in the future — someday.
It goes to show that not all decisions are well-calculated and thought through.
Mistakes can and do happen – even by the biggest of investors.
Quick Takes
+India’s annual inflation rate fell to 5.48% in November (vs 6.21% in October). Rural inflation fell to 5.95% (vs 6.68%) and urban inflation fell to 4.83% (vs 5.62%).
+Industrial production in India grew 3.5% in October (vs 3.1% in September). The manufacturing sector grew 4.1%, electricity grew 2%, and mining grew 0.9%. All 3 sectors reported a higher growth than the previous month.
+India’s vegetable oil imports rose 40% year-on-year to 1.63 million tonnes in November.
+Tata Motors will increase the prices of its commercial vehicles (trucks and buses) by 2% from 1 January 2025.
+US annual inflation rate rose to 2.7% in November (vs 2.6% in October). Core inflation (excludes volatile items like fuel and food) remained unchanged at 3.3%.
+Coca-Cola has sold a 40% stake in its Indian bottling unit, Hindustan Coca-Cola Beverages, to the Jubilant Bhartia Group for over Rs 10,000 crore.
+SEBI will implement an optional T+0 settlement cycle for the top 500 stocks (by market cap as of 31 Dec). Starting on 31 Jan 2025, the rollout will begin with the bottom 100 of the top 500 stocks, adding 100 more stocks in a sequence.
+Gross NPAs (non-performing assets) for public sector banks stood at Rs 3.16 lakh crore (3.09% of total loans), and for private banks, it stood at Rs 1.34 lakh crore (1.86% of total loans), as of 30 September: Minister of State for Finance.
+The RBI has appointed Sanjay Malhotra as the new governor for a 3-year term. He currently holds the position of Secretary (Revenue) in the Finance Ministry.
+Automobile sales rose 11.21% annually to 32,08,719 units in November. Passenger vehicle and commercial vehicle sales fell 13.72% and 6.08%, respectively. 2-wheelers rose 15.80%, 3-wheelers rose 4.23%, and tractors rose 29.88%: FADA.
6-Day-Course
Theme of the week: biggest industries in India
We’ve reached the end of this week’s course that started on Monday. Here’s a test you should take. Get pen and paper!
Question 1:
Which sector contributes the most to India's Nifty 50 index?
-Technology
-Energy
-Finance
Question 2:
The energy sector in India is almost equally weighted in Nifty 50 as the technology sector.
-True
-False
Question 3:
Which sector benefits the most from India’s growing middle-class population?
-Automobile
-Consumer
-Construction
Question 4:
The construction sector makes up more of Nifty 50 than the automobile sector.
-True
-False
Question 5:
What primarily impacts the revenues of Indian tech service companies?
-Food inflation
-Global oil prices
-US company revenues
Answers:
Q1: Finance
Q2: True
Q3: Consumer
Q4: False
Q5: US company revenues
The information contained in this Groww Digest is purely for knowledge. This Groww Digest does not contain any recommendations or advice.
Team Groww Digest