Published On: Thu, Jun 10th, 2010

Algos Gone Wild on the OSE

Deutsche BankOn June 1st during the first few minutes of the morning session at the Osaka Securities Exchange (OSE) a prop desk at Deutsche Securities sent several orders to sell the Nikkei 225 and the mini Nikkei 225 futures. These orders were “repeatedly sent to the exchange” by “an internal trading systems error” according to a press release issued by David Hyatt President & CEO of the firm. The statement continued “a limited number of orders [were] repeatedly sent”. However, according to a Bloomberg news release there were 980,000 orders sent.

The future opened down 1.1 percent with orders valued at US$104 billion according to Bloomberg. Luckily, these were limit orders between 9,690 yen and 9,700 yen but what if they had been market orders? The futures would have sold down the 20% limit and caused the exchange to halt trading. Not only that how many buy side algo strategies would have kicked in and joined the sell off? Or retail stopped out with market orders?

It would have been the “Asia Flash Crash” and would have sent a ripple (tsunami) around the world. And likely a field day for the anti-high frequency trader camp possibly profoundly effected, what I feel to be an important market participant, by reactive regulators.

In this case though I believe it is the risk system that failed at DB and not predatory algorithms. It could have been just 1 order for 980,000 contracts instead sent with the click of a mouse. It is clear that there was no maximum margin limit or maximum order limit set to stand in the way of these trades before they hit the exchange. Setting limits is Risk 101. The point of a risk system particularily in leveraged futures trading is to prevent exactly this kind of scenario from happening. Their role is to protect the firm from rogue traders or algos gone wild.

The market traded down to 9,658 and closed at 9,743 and given the scale of the short futures position I am sure the prop desk took a huge hit and maybe even risked the solvency of the firm. Perhaps, more significantly, could have undermined the stability of a very fragile global financial industry. I’ll be reading the next quarterly report from DB as they will have to disclose the amount of this loss.

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  1. […] This post was mentioned on Twitter by Giles Nelson, John Bates. John Bates said: RT: @gilesnelson Deutsche Securities internal trading system error caused 980,000 orders 2B sent 2 Osaka exchange […]

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