Mom-and-Pop Investors Shrug at Knight Capital Fiasco

by Dan Burrows | August 2, 2012 2:38 pm

Looks like a Terminator shot itself in the foot.

Knight Capital (NYSE:KCG[1]) is scrambling for an injection of capital after one of its high-frequency trading algorithms went berserk Wednesday, causing crazy movements in nearly 150 stocks[2].

But after more than a decade of crushing stock market disappointments, do mom-and-pop investors even care about these self-inflicted wounds?

Knight is one of the largest market makers in the U.S., doing about $20 billion worth of transactions a day. The technical glitch cost the firm $440 million before tax, or about a quarter of its tangible equity after tax.

Shares plummeted more than 75% since Wednesday, and Knight said it is “pursuing its strategic and financing alternatives” as it tries to stave off a dearth-of-equity death spiral.

It’s just the latest embarrassing flop for the wonky world of high-frequency trading[3]. The rise of the machines on Wall Street — computer programs that blast out buy and sell orders in fractions of a second — looks less like Skynet and more like the Three Stooges all the time.

First there was the mother-of-all glitches, the Flash Crash of May 2010, when the Dow Jones dropped nearly a thousand points in a matter of minutes.

Then there was the BATS humiliation[4], in which the giant electronic exchange had to cancel its own IPO because it couldn’t price its own shares on its own platform.

And in case you thought the problems were limited to the new entrants to the exchange business, Nasdaq OMX Group (NASDAQ:NDAQ[5]) famously faceplanted[6] on the Facebook (NASDAQ:FB[7]) IPO.

No, these fiascos are not very reassuring. A general public already wary of Wall Street can’t think more highly of the stock market amid such epic technical failures.

But the glitches hurt traders much more than most investors, who — at the retail level, anyway — already have thrown in the towel on stocks.

Most folks participate in the market through retirement plans. The gyrations caused by Knight, the Facebook failure, even the Flash Crash, didn’t really do any lasting damage to their 401(k)s and IRAs.

And, after two giant market crashes in the span of a decade, folks have been giving up on equities for years. Cash has been pouring out of equity mutual funds and into bond funds or foreign funds for four years now. Almost $130 billion flowed out of U.S. stock funds in the year ended June 30, according to Morningstar.

These technical glitches are hell on traders and smaller active investors, but the great majority of Americans probably are oblivious to flash crashes and other self-inflicted market injuries.

The machines just gave themselves another black eye, but mom-and-pop investors most likely don’t know or don’t care. Stocks still are 15% below their pre-crash peak, home prices still are at 2003 levels and unemployment is destructively elevated.

No, the machines aren’t doing the market any public relations favors, but after everything that U.S. investors have been through since the dot-com crash, it’s at most a case of incremental harm.

As of the writing, Dan Burrows held none of the securities mentioned here.

  1. KCG:
  2. causing crazy movements in nearly 150 stocks:
  3. high-frequency trading:
  4. BATS humiliation:
  5. NDAQ:
  6. famously faceplanted:
  7. FB:

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