Inside Wall Street's Computer Meltdown

Were the computer glitches that exacerbated the downward trajectory of the market Tuesday illustrative of the dark side—the Achilles heel—of the markets' move toward more electronic trading? Or were they bumps along the learning curve—"growing pains," as one trader described them—that will ultimately lead to smoother trading?

"On Tuesday at around 2 p.m., the market's extraordinarily heavy trading volume caused a delay in our trading system," explains a spokesperson for Dow Jones & Co., the media company that manages the index of 30 blue-chip stocks. For 70 minutes, a slow data feed to the Dow Jones industrial average (DJIA) calculator meant that traders were working off a slightly outdated set of numbers. When the error was caught, the system was switched to a backup server that immediately readjusted the figures—sending numbers across the board into a free-fall plunge of 178 points in a single minute.

"When they put the backup system in, [the market] went kerplunk," Alfred E. Goldman, chief market strategist at A.G. Edwards & Sons Inc., tells NEWSWEEK. "That just scared the heck out of a lot of folks. Frankly I felt it created a buying opportunity, but I'm a little bit nuts." At the very least, he was in the minority—the eye-popping adjustment helped lead to the market's biggest single-day drop in almost four years, a total decline of 416 points.

The DJIA data-feed delay wasn't the only problem created by computers Tuesday. As a part of its months-old hybrid system, many NYSE traders now use electronic programs that automatically place buy or sell orders when the market shifts—even when the shift is a partial head-fake. This is precisely what happened with several large stocks after the Dow's plunge, leading to a traffic jam at the NYSE in the Designated Order Turnaround system. Known on the floor as DOT, the system serves as a way to route orders through the exchange. DOT is used by brokers to request data and get stock quotes in addition to buying or selling stocks. When the Dow dropped, traders flooded DOT with requests, causing it to slow significantly.

In an interesting twist, it was the human side of the exchange that helped smooth out the wrinkles caused by the Dow's new high-tech setup. Like an army of number-crunching John Henrys, floor traders whipped out their pens and pads to settle trades manually. "I was happy to be recognized as a human being," says trader Doreen Mogavero of Mogavero Lee & Co. "I don't have any misgivings in particular about the new hybrid system. But I am much more comfortable knowing that there are people here as well as machines."

So did technology make the Dow drop further or faster than it otherwise would have? It was certainly on its way down to begin with—a market crisis in Asia combined with cautionary remarks by former Federal Reserve chairman Alan Greenspan about a potential recession and news that durable-goods orders were tanking to create "a perfect storm" of a bad trading day, according to Komal Sri-Kumar, chief global strategist of Trust Company of the West. "It should have declined more gradually," says the Dow's Reitz. "But it was happening already." Still, many traders agree that the suddenness with which the drop registered caused some to panic and sell—potentially worsening the effect. "The market is made up of fellow human beings," says Goldman of A.G. Edwards. "We're all a little bit neurotic. I know that when I feel like I'm going to regurgitate, it's time to buy stocks. Whereas a neophyte is going to go into the bathroom and regurgitate."

Dow Jones blamed its machine meltdown on Tuesday's unusually high volume of 4.5 billion trades, but it has yet to fully explain what happened. "We're trying to figure out why there being an exceptionally high volume of trades triggered the glitch," says Reitz. They're not alone: the Securities and Exchange Commission is making inquiries, too. "The only thing we care about is if markets that open for business are ready for business," says John Nester, the commission's director of public affairs. "Our staff is working closely with the New York Stock Exchange and the other market centers to review Tuesday's events to evaluate how orders were handled and whether any enhancements to capacity management are necessary."

Many traders remain cautiously optimistic about their brave new world. "You're going electronic, there's definitely going to be kinks," says Todd Leone, head of listed trading at Cowen & Co. "It's not a perfect system right now. It worked fairly well Tuesday. Eventually, it will become much better system." In the meantime, traders may have to keep those pens handy.