Knight Capital's Surprise $7 Billion Bounty

They say that people with OCD such as compulsive gamblers or shoppers often slip into fugue states where they go on their particular binge only to wake up to find the scale of what they had done. In the case of compulsive shoppers they will ask, 'Did I really buy all that?!'

Imagine how traders inside Knight Capital felt after they realized that their brand new trading algorithm that went live on August 1st had bought. Fortunately, the damage from the rogue algo was almost immediately apparent. According to a report in the Wall Street Journal, their runaway algo went on such an enormous buying spree that at one point the market maker owned nearly $7 billion in stocks on that fateful day last week.

What other high finance firms have crashed and burned? Check out Wall Street's 5 Biggest Tech Fails.

Seven billion dollars in stocks acquired in 45 desperate and apparently unstoppable minutes. In less than one hour, this second-tier investment firm - respected for its technology and strong leadership - became one of the largest trading firms on Wall Street.

While scrambling to shut down the runaway algo, traders inside Knight Capital also had to unload as much of the new stock it had unwittingly acquired as the allegedly untested trading algorithm did its damage. By the end of the trading day, the WSJ and Reuters report that the firm had reduced the spending spree tally down to a slightly less dire $4.6 billion.

According to Reuters:

The position led to a $440 million loss that forced Knight to secure a $400 million bailout from a group of independent investors in exchange for a 73 percent stake.

The exposure would have prevented the brokerage from opening for business the next day due to lack of capital required by regulators to offset risks from holding the stocks, the newspaper reported.

As the dust settles from the Knight Capital debacle, all eyes are on the technology used and ignored inside the market maker. Reports claim that the brokerage failed to have a "kill switch" in place and that the algorithm was untested. According to Reuters, a "spokeswoman for Knight also said that the brokerage had not reached a decision yet on an outside firm coming in to review the technology problem that drove the wayward trading... "

What must the traders inside of Knight been thinking? I wonder if a few lines from the Talking Heads song "Once In a Lifetime" came to their minds:

"What have I done? How did I get here?"