Fat fingers and risk management

Filed in archive risk on May 9, 2010

Much has been said over the last few days about the so-called "fat finger" error which caused the Dow Jones to have a nervous breakdown last week and collapse when a trader, reportedly at Citigroup, typed "b" for billion, instead of "m" for million in a trade of Proctor & Gamble shares at a time when the market was already on edge because of fears that the Greek Government might default on its debts.

We can have a debate about whether the typo actually caused the problem, or whether it was due more to traders panicking about the contagion from the Greek tragedy spreading around the world.

But it also raises some important questions about the risk of computer driven trading governed by mathematical algorithms. As the Financial Times says, today's stock markets are governed by these algorithms programmed to jump in and out of the trades at the speed of light, desperately searching for trades that yield a quick profit.

What happened last week raises serious doubts as to whether exchanges and brokers have the risk management systems to guard against algorithms running wild, and protect them from these "fat finger" trades. Reuters reports that regulators are looking to control this through trading restrictions and circuit breakers.

Whether brokers will implement better risk management systems and risk assessment remains to be seen. Not when they're making billions from jumping in and out of trades at lightning speed. As always, that means investors will continue to get screwed.