Better Alternative Trading System?

Mar.27.12 | About: BATS Global (BATS)

Could it get any more ironic? BATS Global Markets (BATS:BATS), which made is debut on Friday, saw a flash crash in its own shares. Consequently all trading halted and the company even took the rare step of withdrawing its initial public offering.

Friday was the initial public offering for BATS own shares. Going public at $16 a share, trading opened around the $15.25 level. For some reason, things went very wrong in the morning. The official reading is that installation of the IPO software triggered a bug, which affected a range of stocks starting with symbol letter A or B.
Irrespective of the actual cause, in a matter of 900 milliseconds shares moved from $15.25 to lows of $0.04 in an extraordinarily smooth manner. In similar time intervals shares trades lower following each trade in an exponential manner, which almost looked artistic.
In a reaction to the enormous fiasco of the IPO, which caused a lot of uncertainty among the new investors, the company decided to withdraw its IPO.

Apple shares
Besides erroneous trades in BATS there was also a mistrade in Apple (NASDAQ:AAPL). 100 shares in the tech giant traded at $542.80, some 10% below its current market price. As recently as last Tuesday there was another small crash in Apple's shares, which fell from $600 to $570 per share.
Shares around $570 level all got busted, but a trade at $582 stood firm causing a lot of uncertainty for investors who face enormous uncertainty whether their order fills stand in volatile environments.

Bats history
Founded in 2005 the company has seen rapid expansion and is now the third largest stock exchange operator in the U.S. The exchange, which has a strong focus on technology holds, 11% market share for stocks and 3% for options. The company expanded in 2011 in Europe by buying Chi-X for $300 million. The combined entity of Chi-X and Bats holds a market share of mid twenties on the old continent.
The withdrawal of the IPO delays the expansion plan for the future and undermines investor confidence in the company and wider stock markets in general. Besides the fact that institutional investors ran away, there is the possibility for lawsuits given that actual market trades occurred in the stock before the company withdraw its IPO plans.

Confidence in the market
This incident does not stand alone. The famous flash crash on Wall Street, during which over $1 trillion in market value vanished in a time span of a couple of minutes, has highlighted the problems of computerized high frequency trading algorithms in combination with fragmented stock exchanges.
It is not just the value swings, it is more the confidence in trade execution and the fact that without human intelligence, computerized algorithms trade on prices which do not make sense.

Regulatory intervention
Friday's events do not stand alone. Regulators have to stand up to restore investor confidence in the market. The fragmented equity and option markets in combination with computerized algorithms created a lot of mini-crashes over the last couple of years.
Exchanges and regulators could send a strong signal by no longer automatically busting "erroneous" trades. In this manner "software bugs" or runaway trading algorithms could be terribly costly for those causing the mini flash crashes.
While the large banks engage in moral hazard as they know they are too big to fail, high-frequency firms operate under the same assumption knowing that trades will get busted anyway.

Perhaps regulators should take over BATS' mission: "Making markets better"

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.