The latest trend on Wall Street is a practice called high-frequency trading. As this story out of MIT makes clear, it could be as big a risk as the mortgage market was.
The crash in 1987 has been blamed in part on the automated selling of stocks. As the market fell, more and more systems automatically sold. It turned what might have been a small correction into a collapse. In this case, we have computers making much more complex decisions automatically and very quickly. The interactions between the different systems are not well understood.
Currently, this kind of trading is accounting for 61% of all trading volume. Anything taking up that much volume deserves a close look. At the rate these systems are trading, orders are placed at 1,000 per second. If something were to go wrong, we could have a fullscale collapse due to something as simple as a coding error in under 10 minutes. It is not clear that the markets are able to handle that kind of volatility.
The traders argue that they are creating value by increasing liquidity. Unfortunately, that’s the exact same line used by the firms behind the complex derivatives that just finished tanking the economy.