How to Survive the Big Board's Next Panic Attack

When the Dow loses 3.3 percent in one day, including a 500-point nosedive, people notice. But they don't always realize that the computer system that helps keep trades moving actually contributed to the panic. That's what happened on Tuesday, February 27, at the New York Stock Exchange.

Jim Zarroli of National Public Radio reported one of the most colorful quotes of the day on the topic. He interviewed the chief investment strategist of Standard & Poor's about the Dow dropping 200 points in a matter of minutes around 3 p.m. "I was quite taken aback by the magnitude of the numbers reeling off – it was almost as if somebody was spinning an odometer illegally," Sam Stovall said.

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It turns out that besides the slow-moving computer that wasn't crunching the Dow Jones industrial average fast enough, other computers couldn't handle the onslaught of trades. Reports show that trades took double their normal amount of time and that many trades at the end of the day simply didn't get executed.

Wait a minute – that's not supposed to happen at the New York Stock Exchange in 2007!

It's the best in the world! We've got computers! But happen it did. And it's not as though there haven't been warnings. One year ago, the second-largest stock exchange in the world, the Tokyo Stock Exchange, shut down all trading when its computer system faltered under the strain of handling nearly 4.5 million trades.

Trading volume is what strained the NYSE's system, too, with about 2.4 billion shares trading on February 27, the highest volume since last June. The Wall Street Journal reported that traders were not at all happy with the slowness of the new online trading systems: “'The biggest thing [Tuesday] pointed out in my mind is that the systems are not adequately prepared to handle the trading volumes,' said Pat Fay, head of listed trading at D.A. Davidson."

For anyone who has contemplated a future stock market crash, there is only one soundtrack: the sound of computers crashing. Bob Prechter, financial forecaster and founder of Elliott Wave International, envisioned and wrote about these problems in his book Conquer the Crash , first published in 2002:

Trading stocks, options and futures could be extremely problematic during a stock market panic. Trading systems tend to break down when volume surges and the system’s operators become emotional. To give you a flavor of what goes on, read this description, from one of my subscribers, of the tumult during a comparatively mild panic forty years ago:

"I worked for Merrill Lynch in New York in 1962 during the collapse. I well recall the failure of the teletype in our office and inexperienced clerks calling in the orders to the main office. I recall many of the screw-ups: buys called in as sells and vice versa. Some stocks had nicknames like Bessie (Bethlehem Steel), Peggy (Public Service Electric and Gas), and I recall the clerks calling in the orders by the stocks’ nicknames and the person on the other end not knowing what the hell they were talking about. All the while, the market was collapsing."

Do you think the experience will be “smoother” because modern computers are involved? I don’t. In fact, today’s system — much improved, to be sure — is nevertheless a recipe for an even bigger mess during a panic. Investors will be so nervous that they will screw up their orders. Huge volume will clog Web site servers, disrupting orders entered online. Orders may go in, but confirmations may not come out. A trader might not know if his sale or purchase went through.

Sound at all familiar? The Wall Street Journal also reported that one company that measures how well online trades are executed said that "most of the leading online trading sites took up to double the average length of time to complete online trades. It also estimated a 25 percent decline in the number of trades able to be successfully completed during [Tuesday's] sell-off."

It's a living nightmare not to be able to maneuver when the markets are wild, as they were on February 27 – and will be again someday. But rather than putting faith in the New York Stock Exchange or Dow Jones & Co. (DJ) to fix their technology problems, it's time to realize that the stock-trading system is subject to disruption from human emotion.

If too many people get scared and want to sell, it doesn't matter how well the computer system works under ordinary circumstances. It will still be crushed by the stampede of sellers. And according to the analysts at Elliott Wave International, Tuesday was a mild case; thanks to bulls who haven’t sold. Bigger panics lie ahead.

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Here's some tried-and-true advice: Avoid getting into trading positions that will bankrupt you if computers shut down for an hour or two, or a day or two. If you plan to lighten your stock holdings, do it on calm days, before the next panic prevents you from acting as you wish.

Susan C. Walker writes for Elliott Wave International, a market forecasting and technical analysis company. She has been an associate editor with Inc. magazine, a newspaper writer and editor, an investor relations executive and a speechwriter for the Federal Reserve Bank of Atlanta. She is a graduate of Stanford University.