Algo Bots: The Risk of Human Error...

What "Trust Decisions" did you make this past week?  How fast did you make them?  The ability to manage an entire portfolio of operational risks in a daily routine is daunting.  How do you prioritize? What Operational Risk Management (ORM) process will you engage in, with so many uncertain outcomes?  Why will you sit up in bed at 3AM, to read the latest alert on your smartphone?

In October of 2012, this ORM blog discussed the topic of "Algo Bots" and "Dark Pools".  Machine language talking to other machines, to make optical network speed decisions and more precise, "Trust Decisions."  What is the risk of a low probability and high consequence incident when humans are taken out of the equation?  Dave Michaels of Bloomberg explains the current focus:

Mary Jo White’s blueprint for imposing tighter controls on high-frequency traders and some of the murky venues they inhabit stops short of a crackdown. 

The U.S. Securities & Exchange Commission’s plan, unveiled by White in a speech this week, advanced some new ideas while borrowing heavily from existing proposals and measures that already have support on Wall Street. While stock exchanges, rapid-fire traders and private trading venues known as dark pools all would come under new scrutiny, White didn’t embrace the kind of tighter restraints that have been enacted in countries such as Australia and Canada. 

White isn’t acting in a vacuum. She is responding to political pressures raised by an investigation by the New York attorney general into whether speed traders prey on slower-moving investors as well as a book by Michael Lewis, “Flash Boys,” that condemned the role of exchanges and brokers in enabling unfairness. She announced the initiatives even as she said U.S. markets aren’t rigged and serve the goals of retail and institutional investors.

As an Operational Risk Management (ORM) professional, you have to stay on the edge.  You must imagine the future and dive into the current R&D of innovation.  Being a futurist is staying on the bleeding edge of technology and this is just one facet of the risk mosaic.  The other and more human factor oriented component are the TTP's.  Tactics, Techniques and Procedures (TTP) are what you need your own "Opposition Research" team to be studying.  This is your opportunity to gather the intelligence on your competition and simultaneously look at your own vulnerabilities.  Sam Mamudi and Keri Geiger explain:

The U.S. Securities and Exchange Commission cited Wedbush Securities Inc. and Liquidnet Holdings Inc. for violations of stock market rules, taking tangible steps a day after Chairman Mary Jo White outlined her plan to improve Wall Street trading. 

Wedbush, which the SEC said is among the five biggest Nasdaq Stock Market traders, failed to vet clients who broke the law as they placed billions of dollars of transactions in the stock market, the regulator said. Two current and former Wedbush executives, Jeffrey Bell and Christina Fillhart, were also targeted in the complaint. 

Liquidnet, one of the biggest independent dark pool operators, agreed to pay a $2 million fine for not living up to client secrecy standards on its private trading platform.

So what?  The Rise of the Machine Traders:

In the beginning was Josh Levine, an idealistic programming genius who dreamed of wresting control of the market from the big exchanges that, again and again, gave the giant institutions an advantage over the little guy. Levine created a computerized trading hub named Island where small traders swapped stocks, and over time his invention morphed into a global electronic stock market that sent trillions in capital through a vast jungle of fiber-optic cables. 

By then, the market that Levine had sought to fix had turned upside down, birthing secretive exchanges called dark pools and a new species of trading machines that could think, and that seemed, ominously, to be slipping the control of their human masters. Dark Pools is the fascinating story of how global markets have been hijacked by trading robots--many so self-directed that humans can't predict what they'll do next.

So how do you mitigate the potential risk of a rogue algorithm? Some have devised a mechanism called a circuit-breaker. In other words, an alarm that something is not normal. Let's slow down until we can understand what is going on here. What are some other ways that we could potentially address the threat or the vulnerability? Was the "Flash Crash" a weak signal of a pending melt down of the complete system?

Or is this just the next natural phase of the future growth curve.  Who will you put your faith in for your next "Trust Decisions"...

operational risk