Beware the weight-challenged digits

Fat fingers (or weight-challenged digits to my politically correct friends) have had a good run lately. First we heard that Deutsche Bank had to close its quantitative trading desk in Japan after an automated trading system misread equities market data. The system generated a massive sell order that caused the Nikkei 225 Stock Average to dive (full story here: http://tinyurl.com/23rnn5v). Then an unknown trader spiked the Swedish krona and a computer glitch at Rabobank smacked sterling by about 1%, according to the Wall Street Journal (http://tinyurl.com/2el9kgw).

Although the press was surprised that the efficient foreign exchange market was susceptible to trading errors, it is just as vulnerable as equities or futures. In FX, trades are often made directly to an FX trading destination such as EBS, Reuters or Currenex. In many institutions, trades are often made without adequate pre-trade checking or risk management applied.

As my colleague, Deputy CTO - Dr. Giles Nelson, told the Wall Street Journal: “The consensus in the market is that this was a computer-based trading error, but ultimately there would have been a human involved somewhere.”

Human error is part of being human. The reality of highly automated trading is that the programs are built by humans and run by super-fast machines. And unless there are robust computerized checking mechanisms that vet trades before they hit the markets, errors can wreak havoc in the blink of an eye.

Deutsche Bank's algorithms generated around 180 automated sell orders worth up to 16 trillion yen ($183 billion) and about 50 billion yen's worth were executed before the problem was addressed. The Rabobank mistake could have dumped £3 billion worth of sterling into the market in one lump, rather than splitting it up to lower market impact - but luckily the bank spotted the error and stopped the trade before it was fully completed. The Swedish krona mistake sank the krona against the euro by 14% before it was spotted. 

Pre-trade risk checks would help to prevent errors, trade limit breaches, or even fraudulent trading from occurring. And pre-trade risk controls need not be disruptive.  Ultra-low latency pre-trade risk management can be achieved by trading institutions without compromising speed of access.  An option is a low latency "risk firewall" utilizing complex event processing as its core, which can be benchmarked in the microseconds. 

With a real-time risk solution in place, a message can enter through an order management system, be run through the risk hurdles and checks, and leave for the destination a few microseconds later. The benefits of being able to pro-actively monitor trades before they hit an exchange or ECN or FX platform far outweigh any microscopic latency hops. They include catching fat fingered errors, preventing trading limits from being breached, and even warning brokers and regulators of potential fraud - all of which cost brokers, traders and regulators money.