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US regulators investigate high frequency trading safeguards

High profile malfunctions prompt probe into algorithmic code testing and deployment processes

US regulator Financial Industry Regulatory Authority (Finra) has launched an investigation into the safeguards put in place by high frequency trading firms, following a number of high profile software glitches.

High frequency trading (HFT) is the practice of using computer algorithms to conduct huge volumes of trades in fractions of a second, buying and selling on different trading platforms to make a large number of small profits.

In order to gain a better understanding of the controls and processes employed by HFT firms, the regulator has requested a detailed list of employees involved in developing and testing of code used in the production of trading algorithms.

The examination is aimed at showing whether there is any separation or independence between those writing code, and those providing quality assurance, for example. This will also help to determine whether traders themselves are involved in writing, developing, testing, or modifying algorithmic code.

Another of the questions being asked by the regulator is whether there are any automatic or manual 'kill-switches' in place at HFT firms that are able to stop trading in the case of system failures.

Finra has also requested that the firms should come clean about any malfunctions with algorithms or trading engines which led to "market disruption".

The investigation is aimed at preventing the problems at a number of exchanges, which have occurred as a result of computer glitches in HFT platforms.

The 'flash crash' of 2010 tarnished the reputation of HFT, with the Dow Jones industrial index to plummet by 1,000 points, before regaining losses within three minutes.

A joint US Securities and Exchange Commission (SEC) and the Commodity Futures Trading Commission (CFTC) report laid the blame on an automated trade execution system which flooded the Chicago Mercantile Exchange's Globex electronic trading platform with a large sell order.

Following the 'flash crash' Finra brought in new rules requiring a pause in the trading of individual stocks when the price moves 10 percent or more either way in a five minute period.

Also, in 2012 the accidental reactivation of old computer software led to a glitch in Knight Capital's trading software, resulting in losses of about £281 million. Knight Capital staff had to sift through eight different sets of software before they were able to determine the cause of the problem.

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