City analysts and regulators are warning that the widespread increase in algorithmic trading bots across global markets could “overwhelm” the trading systems currently facilitating the world’s major stock exchanges, leading to repeat scenes like the Dow Jones flash clash where markets shed over 1000 points in a matter of minutes and in the worst-case scenario resulting in total market collapse.

Programmed to respond to market movements in pre-determined ways, computerized trading systems can compound negative market movements to throw indices into turmoil, leading to significant depressions like those seen in the flash crash over little to no time at all, presenting a dangerous and more volatile market dynamic for ordinary traders without access to sophisticated, algorithmically-driven systems.

Utilized extensively by hedge funds and institutional investors, algorithmic trading systems are designed to remove the human component from trading and to establish set rules to protect portfolios.

However, with little to no regulatory oversight of these algorithmic systems, and their potential to compound downward spirals over a short period of time, the concerns that algorithmic trading could destroy markets seem to be well founded.  And with some analysts suggesting that up to two-thirds of US equity trading may be handled by automated algorithmic trading systems, the potential dangers posed by the downward impact of multiple similarly-behaving algorithms could be vast.

Last Updated: August 23rd, 2010