Programmed Trading and Erroneous Trade May Have Contributed to Stock Market Meltdown

On a wild crazy day on Wall Street the Dow Jones Industrial Averages plunged nearly 1000 points before recovering to finish the day 347 points lower at 10,520.32. Starting at about 2:20 PM the market plunged seven hundred points within 20 minutes, then in the next 20 minutes rallied almost 600 points. After the bell traders were talking about how programmed trading and an erroneous trade may have contributed to the stock market meltdown.

A spokesman for Citigroup said on Thursday that the bank is investigating a rumor that one of its traders entered a trade that helped precipitate a drop of almost 1,000 points in the Dow Jones Industrial Average.

One NYSE employee leaving the Big Board’s headquarters in lower Manhattan said the P&G share plunge lay at the center of whatever happened. “I’ll give you a tip,” the employee said, speaking on condition of anonymity. “P&G. Check out the low sale of the day. Something screwed up with the system. It traded down $30 at one point.”

Nasdaq said it was working with other major markets to review the market activity that occurred between 2:00 p.m. and 3:00 p.m., when the market plunge happened.

Traders were obviously rattled by the extreme market volatility. Over the past two weeks concern over the Greek sovereign debt issue had already placed traders on edge as the stock market at best showed signs of entering a substantial correction phase. Experienced traders have been concerned for some time that high frequency program trading, using ultra fast computer systems, may experience problems once substantial selling enters the market. The fear, which seemed to be realized in today’s volatile price action, is that on the down side fairly light volume could trigger a substantial market sell-off. Heavy volume could trigger a panic situation such as we saw today.

As if the program trading algorithms weren’t by themselves cause for concern rumors abound that an erroneous trade in Procter & Gamble stock may have precipitated the panic and plunge in a market that was already struggling to overcome selling pressure. Regardless of the cause or causes for the highly volatile crazy price action it was a dangerous day to be trading stocks or calls and puts.

For example, I had entered some “just in case” limit prices on some put positions that were well above the market price and that I really did not expect to be filled. However, the high print of the day was well above my “just in case” price. Unfortunately, my online trading service failed during the plunge, I expect to extraordinary high volume, and my put options were not executed. Of course, all Internet-based stock trading services cover themselves for electronic service failure in their customer agreement so it is just tough luck for the retail customer when such an event takes place.

I believe that a trading day like today is a huge negative for the stock market. There are already signs that the tremendous rally from the March 2009 lows to recent highs is over. With the bear market resumption gaining momentum, errors in program trading algorithms, electronic trading errors, and erroneous trades that cause tremendous market disruption create for retail stock traders a justified lack of confidence in Wall Street.

I expect that many retail traders will review today’s price action and be completely disgusted with what they see. Many traders already feel that Wall Street has stacked the deck against them. Do not be surprised if the sell me out orders pour in over the next several days and probably for a long time to come as retail traders withdraw from the stock market.