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Yesterday's (May 6) stock plunge and computational finance

For those following financial news, yesterday was a crazy day on the stock market. Financial markets around the world have already been on a perpetualroller coasterride because of sagging economic growth in Europe, especially in Greece. But yesterday, the DOW took its single largest plunge in history - an almost 1,000 point-loss (about 10% of the market) in less than half an hour.

Analysts are straining to figure out what exactly caused this fall. Rumors and conjectures have been swirling around the media for lack of better information. Although the stock market recovered most of the value it had lost before closing on May 6, people rightly want to discern what were the causes of the brief crash.

Tim Paradis of the Associated Press reports some of the current explanations for yesterday's price fall. One idea is that a trader mistakenly entered $16 billion instead of $16 millioninto a sell order. Another possible trigger is a mis-listing of the price of Procter & Gamble stock, which caused massive selling of that stock and a subsequent 37% drop in its price.

After listing these theories, Paradis concludes,

Whatever started the selloff, automated computer trading intensified the losses. The selling only led to more selling as prices plummeted and traders tried to limit their losses.

""I think the machines just took over. There's not a lot of human interaction,"" said Charlie Smith, chief investment officer at Fort Pitt Capital Group. ""We've known that automated trading can run away from you, and I think that's what we saw happen today.""

In a nutshell, when financial computers detected a significant drop in the stock market (be it from the erroneous $16 billion dollar sell order or from mist-quoting Procter & Gamble stock price), they saw this as a sign that stocks were losing value. Then, they automatically sold shares, which caused even more devaluation and selling.

While it is true that inadequate computational models may have been partly to blame for both the recent recession in general and yesterday's price plunge in particular, it is important to keep this criticism in perspective.

Computational finance is still an industry in its infancy, and like with all human devices that fail at some time, it's no use blaming the device for the failure. We should blame human error. For example, if a bridge collapses somewhere, we don't blame the physical structure itself; we seek to find the faults in our own engineering plans that caused the accident.

Computational finance, using mathematical algorithms to make sense of the stock market, offers much promise in making sense of the seemingly-chaotic world of financial trading. As computers grow more powerful, they will be able to answer the most difficult questions in finance, and the stock market may cease to seem so arbitrary. This industry should be allowed to develop, but with sufficient checks in place and smarter algorithms to prevent shocks like the one that happened yesterday.

Yesterday's (May 6) stock plunge and computational finance

For those following financial news, yesterday was a crazy day on the stock market. Financial markets around the world have already been on a perpetualroller coasterride because of sagging economic growth in Europe, especially in Greece. But yesterday, the DOW took its single largest plunge in history - an almost 1,000 point-loss (about 10% of the market) in less than half an hour.

Analysts are straining to figure out what exactly caused this fall. Rumors and conjectures have been swirling around the media for lack of better information. Although the stock market recovered most of the value it had lost before closing on May 6, people rightly want to discern what were the causes of the brief crash.

Tim Paradis of the Associated Press reports some of the current explanations for yesterday's price fall. One idea is that a trader mistakenly entered $16 billion instead of $16 millioninto a sell order. Another possible trigger is a mis-listing of the price of Procter & Gamble stock, which caused massive selling of that stock and a subsequent 37% drop in its price.

After listing these theories, Paradis concludes,

Whatever started the selloff, automated computer trading intensified the losses. The selling only led to more selling as prices plummeted and traders tried to limit their losses.

""I think the machines just took over. There's not a lot of human interaction,"" said Charlie Smith, chief investment officer at Fort Pitt Capital Group. ""We've known that automated trading can run away from you, and I think that's what we saw happen today.""

In a nutshell, when financial computers detected a significant drop in the stock market (be it from the erroneous $16 billion dollar sell order or from mist-quoting Procter & Gamble stock price), they saw this as a sign that stocks were losing value. Then, they automatically sold shares, which caused even more devaluation and selling.

While it is true that inadequate computational models may have been partly to blame for both the recent recession in general and yesterday's price plunge in particular, it is important to keep this criticism in perspective.

Computational finance is still an industry in its infancy, and like with all human devices that fail at some time, it's no use blaming the device for the failure. We should blame human error. For example, if a bridge collapses somewhere, we don't blame the physical structure itself; we seek to find the faults in our own engineering plans that caused the accident.

Computational finance, using mathematical algorithms to make sense of the stock market, offers much promise in making sense of the seemingly-chaotic world of financial trading. As computers grow more powerful, they will be able to answer the most difficult questions in finance, and the stock market may cease to seem so arbitrary. This industry should be allowed to develop, but with sufficient checks in place and smarter algorithms to prevent shocks like the one that happened yesterday.