The trades were obviously unusual. Soon complex computer programs deployed by financial firms swooped in. They bought undervalued stocks as the unusual sales drove their prices down and sold overvalued ones as the purchases drove their prices up.

History News Network | What Caused the Stock Market Crash of ?

The algorithms were making a killing, and human traders got in on the bounty too. Within minutes, a wave of urgent email alerts deluged top officials at the Securities and Exchange Commission. On Wall Street, NYSE officials scrambled to isolate the source of the bizarre trades. Meanwhile, across the Hudson River, in the Jersey City offices of a midsize financial firm called Knight Capital , panic was setting in.

And no one knew how to shut it down. At this rate, the firm would be insolvent within an hour. By then it was shortly after 10 a. In the four years since the collapse of Lehman Brothers drove the global financial system to the brink of oblivion, new technologies have changed Wall Street beyond recognition.

Stock exchanges can now execute trades in less than a half a millionth of a second—more than a million times faster than the human mind can make a decision. Financial firms deploy sophisticated algorithms to battle for fractions of a cent. Do this 10, times a second and the proceeds add up.

Constantly moving into and out of securities for those tiny slivers of profit—and ending the day owning nothing—is known as high-frequency trading. This rapid churn has reduced the average holding period of a stock: Half a century ago it was eight years; today it is around five days.

Most experts agree that high-speed trading algorithms are now responsible for more than half of US trading. Computer programs send and cancel orders tirelessly in a never-ending campaign to deceive and outrace each other, or sometimes just to slow each other down.

As in , when regulators only seemed to realize after the fact the threat posed by the toxic stew of securitization, the financial whiz kids are again one step—or leap—ahead. A lot of high-frequency trading is done by small proprietary trading firms, subject to less oversight than brand name financial institutions.

But big banks have also tried to get in on the act. Imagine a runaway algorithm at a too-big-to-fail company like Bank of America, which manages trillions, not billions, in assets. Years of mistakes and bad decisions led to the collapse. But when the next crisis happens, it may not develop over months, weeks, or even days. It could take seconds. Alpha, New Jersey, is a sleepy hamlet in the Lehigh Valley, near the Delaware River. Spread is part of a growing industry dedicated to providing hyperspeed connections for financial firms.

A faster trader can sell at a higher price and buy at a lower one because he gets there first.

Because of this, trading firms are increasingly pushing the limits to establish the fastest connections between trading hubs like New York, Chicago, and London. Every extra foot of fiber-optic cable adds about 1.

Exchanges like the NYSE charge thousands of dollars per month to firms that want to place their servers as close to the exchanges as possible in order to boost transaction speeds. When completed in , one of the cables is expected to shave five to six milliseconds off trans-Atlantic trades. But why stop there? One trading engineer has proposed positioning a line of drones over the ocean, where they would flash microwave data from one to the next like the chain of mountaintop signal fires in The Lord of the Rings.

The acceleration of Wall Street cannot be separated from the automation of Wall Street. Since the dawn of the computer age, humans have worried about sophisticated artificial intelligence—HAL, Skynet, the Matrix—seizing control. But traders, in their quest for that million-dollar millisecond, have willingly handed over the reins. Although humans still run the banks and write the code, algorithms now make millions of moment-to-moment calls in the global markets.

Some can even learn from their mistakes. One set of signals the programs have to weigh are countless trade orders other algorithms send out and then quickly rescind. Some speculate they are new algorithms being tested or strategic feints, the equivalent of sonar pings probing the market for a response.

Some of the fake trades could be aimed purely at gobbling up bandwidth to slow down competitors.

Was the Stock Market Drop A Human Error or a Computer Error?

The Dow, already down points on bad news from Europe, had suddenly plummeted another The typically manic Jim Cramer reached a new level of frenzy, shouting at viewers to buy—BUY! Prices of nearly every stock and exchange-traded fund had plunged in minutes. Almost five months later, regulators would conclude that, on a day when traders had already been shaken by the Greek debt numbers, a single massive sell order executed by an algorithm belonging to a firm in Kansas had triggered a series of knock-on events that sent the market into a tailspin.

The flash crash spurred regulators to action—but spurs can only make a horse gallop so fast. No one in Washington makes an extra million bucks a year for moving a millisecond faster, and it shows.

Just imagine what can happen if an automated traffic light flashes green rather than red, if a wing flap on a plane goes up rather than down, if a railroad track switches and sends the train right rather than left. To enhance its market-monitoring capacity, the SEC has had to turn to industry —specifically, a firm called Tradeworx that specializes in very-high-speed trades—for a new computer program to analyze trading data.

That program, called Midas, was scheduled to go online at the end of To fill those gaps, the SEC plans to ask market participants to submit comprehensive information about every trade in the US markets—creating what is called a consolidated audit trail.

Instead, the audit information will be due by 8 a. Meanwhile, the financial world is getting even more fast-paced, opaque, and downright mysterious. The same week Schapiro spoke at the SEC roundtable, an algorithm consumed 10 percent of the bandwidth of the US stock market.

That is pretty darn weird. So far, the problems caused by algorithms appear to be mostly accidental. But what if someone designed a program intended to wreak havoc? After Black Monday in , when the Dow Jones dropped by nearly a quarter in one day, the New York Stock Exchange instituted circuit breakers that halt trading temporarily when the market falls by 10 percent and shut it down entirely when it falls by 30 percent.

Neither of these fail-safes, though, was triggered by the flash crash—the market fell in a blink, but it fell less than 10 percent. After the flash crash, the SEC implemented new circuit breakers that kick in when an individual stock experiences rapid, unusual price swings. New SEC rules slated to take effect in February will halt trading for five minutes if prices of individual stocks move outside of a set range for more than 15 seconds.

If a kill switch or circuit breaker is automatic, it does nothing to reintroduce human judgment.

Conversely, if a person has to pull a kill switch, he or she has to take responsibility for doing so—which creates its own problems. Reformers are advocating what amount to speed limits. In a more far-reaching proposal, Rep. Tom Harkin D-Iowa have proposed levying a financial-transactions tax —they suggest 0.

The United States had such a tax until Economists, activists, and even some finance big shots—Warren Buffett among them—have endorsed the idea. Wall Street lobbyists have pushed back against both speed limits and bringing back the transaction tax.

But in the wake of the Knight episode, some industry experts are expressing doubts about the status quo. The chief executives of publicly traded companies—who are hired and fired based on stock prices—increasingly worry that their shares could be sent into a free fall by an algorithmic feeding frenzy. Then again, the financial sector has a pretty solid track record of stymieing reform. As market-shaking episodes pile up, even some of the tech geniuses who helped usher in Wall Street 2.

Nick Baumann is a former editor at Mother Jones. You can also follow him on Twitter and Facebook. Mother Jones is a nonprofit, and stories like this are made possible by readers like you.

Could Computerized Trading Cause Another Market Crash?

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