My theory on yesterday's trading

Several people have been asking me about what happened yesterday. Here is the main cause (on which I would put some serious prediction money):

Whatever triggered the initial selling (manual error, European fear, etc), the liquidity-TAKING algorithms kicked into higher and higher gears. Liquidity-PROVIDING algorithms took time outs.

The Takers employed market orders (not limit orders that specify the price for execution) that filled their orders without consideration of how bad the execution price was. (For some stocks, e.g. ACN = Accenture, a $40 name, that price got as low as a penny).

These algorithms-gone-wild will get people fired and will also close down trading shops. Unwinding trades will only keep the risky actors around longer, betting that they will get bailed out down the road.

Darwin Awards should not be returnable. If an idiotic robot offered to sell you AAPL for $200 so you could turn around and sell it for $240, you should do it until the cows come home.

UPDATE: Kid Dynamite rounds up some respectable voices who agree with me.

UPDATE: Evan Newmark wants more regulation? Not his usual modus operandi:

As a believer in free markets, I think it is both useless and harmful to constrict computerized trading. But on days like today, it really puts that belief to the test.

The purpose of a stock market is to provide an orderly and efficient market for the free exchange of equity securities. At the core of the market, there must be a belief that the market is trustworthy, that it can match buyers and sellers, bids and asks.

Today’s market was neither orderly nor efficient nor trustworthy. It was just a bunch of computers making ugly, messy love with each other . And your money hung in the balance.

UPDATE: SEC is on the case. I wonder if we will hear their report in 2010, never mind before Memorial Day.

UPDATE: Randall Lane conjures up the Terminator series.

Photo link here.