3 Things You Need to Know About Yesterday's Nasdaq Failure

Although we don't believe in timing the market or panicking over daily movements, we do like to keep an eye on market changes -- just in case they're material to our investing thesis.

U.S. stocks opened roughly unchanged this morning, with the S&P 500 (SNPINDEX: ^GSPC  ) and the narrower, price-weighted Dow Jones Industrial Average (DJINDICES: ^DJI  )  down 0.11% and 0.19%, respectively, at 10:05 a.m. EDT.

All trading on the Nasdaq exchange ceased for three hours yesterday afternoon -- a disruption unusual for its breadth and duration. Here are three things you ought to know about what happened:

It could have been worse
As I noted yesterday, Nasdaq's outage appeared to have virtually no impact on investor sentiment -- which I find quite surprising, particularly when one considers that the market witnessed another technological failure earlier in the week, when one of Goldman Sachs' (NYSE: GS  ) trading systems made a flurry of erroneous trades, after sending incorrect orders to exchanges operated by NYSE Euronext, Nasdaq OMX, and CBOE. According to the Financial Times, the incident could cost Goldman $100 million in losses.

It's certainly easy enough to imagine an uglier reaction; we were probably lucky the outage occurred in August, rather than October!

This type of failure will happen again
The financial markets are too dynamic and the business of financial exchanges has become too competitive to allow exchanges to err on the side of caution and conservatism. Having worked in the software industry, including in a firm that provided connectivity between banks/broker-dealers and exchanges, I can attest to the tremendous pressure organizations are under to achieve time-to-market. The priority is to "ship" software -- minor bugs can be addressed once systems are in production. However, in systems of phenomenal complexity, minor bugs, quick fixes, and workarounds can have unpredictable consequences...

As many of the largest exchanges (including the NYSE and the Nasdaq, which is part of Nasdaq OMX Group (NASDAQ: NDAQ  ) ) are now owned by publicly traded companies, I'd imagine the culture is not much different inside the technology division of these institutions.

Yesterday, I wrote that "when an engineering or technological system gets sufficiently complex, unpredictable failures are certain to occur from time to time." Or, as The Wall Street Journal's E.S. Browning and Scott Patterson summarize with a clever headline to their coverage of the story: "Market Size + Complex Systems = More Glitches."

The investors least vulnerable to these problems are the genuine investors
For the fast-money crowd, including high-frequency traders, market disruptions of this type can be a disaster in the making, with the potential for huge losses. However, if you're a long-term, fundamental investor who buys and sell stocks deliberately and infrequently, the odds are you won't even notice a three-hour market outage. The best way to limit your technological exposure to modern markets is to be a long-term investor (you can also review my list of Best Practices for Long-Term Investors in a Microsecond Market).

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