Software Testing Lessons Learned From Knight Capital Fiasco

Knight Capital lost $440 million in 30 minutes due to something the firm called a 'trading glitch.' In reality, poor software development and testing models are likely to blame. Here's what your company can do to avoid similar embarrassment and huge losses.

By Matthew Heusser
Tue, August 14, 2012

CIO — It took only one defect in a trading algorithm for Knight Capital to lose $440 million in about 30 minutes. That $440 million is three times the company's annual earnings.

The shock and sell-off that followed caused Knight Capital's stock to lose 75 percent of its value in two business days. The loss of liquidity was so great that Knight Capital needed to take on an additional $400 million line of credit, which, according to the Wall Street Journal, effectively shifted control of the company from the management group to its new creditors.

Knight Capital was regulated by the Securities and Exchange Commission, routinely audited and PCI complaint. If that bug could affect Knight, it could happen to any company. At least that's what Knight Capital CEO Thomas Joyce seemed to imply in an interview with Bloomberg Television. "Technology breaks. It ain't good. We don't look forward to it," he says, adding, "It was a software bug....It happened to be a very large software bug."

Thomas Joyce
"Technology breaks. It ain't good. We don't look forward to it," Knight Capital CEO Thomas Joyce says. (Image courtesy of Bloomberg)

This incident wasn't the first of its kind. In 2010, something caused the Dow Jones Industrial Average to drop 600 points in roughly five minutes in what is now known as the "flash crash." Nasdaq blamed the disastrous Facebook IPO on a similar technical glitch.

Mistiming, Bad Orders Crash High-Frequency Trading Algorithm

In early June 2012, the New York Stock Exchange (NYSE) received permission from the SEC to launch its Retail Liquidity Program. The RLP, designed to offer individual investors the best possible price, even if it means diverting trades away from the NYSE and onto a so-called "dark market," was set go live on Aug. 1. This meant trading houses had roughly a month and a half to scramble to write code to take advantage of this new feature.

The Knight Capital incident happened in the first 30 minutes of trading on Aug. 1. Something went very wrong in the code that had been introduced overnight. The code itself was a high-frequency trading algorithm designed to buy and sell massive amounts of stock in a short period of time. A combination of mistiming and bad orders let to disastrous results.

Beyond admitting a software defect, the staff at Knight Capital have been reluctant to discuss exactly what caused the defect. They aren't alone—the majority of financial-related inquires for this article led to responses such as "No comment," I can't comment" or "We cannot comment on this story."

Continue Reading

Our Commenting Policies