See things clearly

Seeing the next flash crash coming

Last week, in “Systems Thinking, Safety and Risk Management”, IBM Fellow Irving Wladawsky-Berger discussed a round table breakfast about, ‘Protecting Financial Markets in the Age of the Cloud

“...Several participants cited the sharp rise in volume and speed of high-frequency trading over the past decade as an example of a current practice that is potentially increasing volatility and systemic risk in financial markets.  They mentioned the flash crash of May 6, 2010 as the kind of incident that is not well understood, and whose recurrence could compromise the stability and general trust needed for financial markets to function smoothly.  At least one of the roundtable participants was convinced that another major event, similar to the global financial crisis of 2008 would inevitably take place in the next few years...”

That anonymous opinion is one that should not be dismissed lightly. 


During  the past 12 months, the trading ‘circuit breakers’ introduced to stop huge fluctuations in share prices have been triggered over 100 times.


To quote from Advanced Trading, and John Bates, CTO of Progress Software,

‘...does this necessarily mean that the markets are safer, or that the structural problems that enabled the Flash Crash have been eradicated?


Not everyone seems to believe that's the case, and the equities markets represent a mere sliver of the overall problem. Even with the controls that have been put in place to date, there continues to be the danger of a multi-asset crash, the likes of which could make May 6, 2010 seem quaint.


The "electronification" of a growing number of asset classes, combined with the increasing cross-asset, international correlations between them, is a recipe for a multi-asset "splash crash"...’

Put another way, there are more flows of data interacting, in more physical locations, in more jurisdictions, than there were two years ago. 


That means there is more risk in the financial system, simply because there are no standards for data flow.  In my opinion, until more clarity is created on how data flows through the people, process and technology of the financial system, that risk will only increase.


To revisit a comment I made back in April 2009,

“...because the IT revolution involves invisible data and information, it is more difficult to spot breakdown in flow. It was obvious to a miller that his water wheel stopped working if something upstream stopped or diverted the flow of water from his river. That a power cut stops a motor turning is clear.


But today, when data stops flowing we don’t always realise it until it is too late. Frozen values on a trader’s screen...could have serious consequences if not spotted prior to decisions being made, whether by people or by computers.


And even if values change, are they changing correctly? Perhaps the exchange rate which is applied to the changing stock values has stopped updating? And sometimes values onscreen will change, but they are incorrect.


We can think of the modern finance industry as one giant calculator with lots of feeds plugged into it. Data flows into the calculator along each ‘pipe’ and as long as all the values are accurate and they get there on time everything is ok. The trouble is traditionally the finance sector hasn’t known when a feed has become blocked or unplugged, so a value is missing or incorrect and the calculator produces the wrong answer as a result...”

In today's complex, data-driven financial world, markets have to constantly understand precisely how they work.  If they don’t, they will continue to court disaster.


As has been argued here before, adapting the methods of the process industries offers the best means to create that degree of clarity.




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