What's up guys and welcome back to wall street millennial on this channel, we cover all things: stocks and investing in today's video we're going to talk about a little-known company that most people have never heard of and most never will, but in high frequency trading. This company once dominated the industry as the world's largest electronic market maker for 20 years. It made insane market returns, peaking in 2011, but then one fatal mistake by a technician at the company destroyed the company's entire legacy. An innocent mistake caused the company's trading system to spit out millions of nonsensical orders to stock exchanges quickly depleting the company's entire balance sheet.

As a result of the trading losses and in a matter of minutes, a giant on wall street was reduced to the laughingstock of high frequency traders. We're talking about none other than knight capital group knight capital group was founded in 1995 and based in new jersey, near new york city. They engaged in electronic market making electronic execution and institutional trading. In other words, they engage in the same type of business as citadel securities providing bids and offers on public stock exchanges for other market participants to trade.

With as a market maker, they were what's called a liquidity provider, which means that they stood ready to either buy or sell a stock at all times, at almost the same price and no matter how volatile the markets were. Whenever another market participant comes to the market. Wanting to buy or sell a stock, they frequently end up trading with electronic market makers like night capital. That's because these market makers are almost always able to offer a competitive price to buy and a price to sell the security.

However, the prices they offer aren't perfectly fair and the spread that they demand from market takers adds up to hundreds of millions of dollars in profits. Each year, night, capital also engaged in specifically trading with retail traders in payment for order flow style arrangements. In these arrangements, night trading, along with other electronic market makers, systematically trade against incoming retail trader orders offering them prices for execution of their orders. They are slightly but not much better than existing market prices.

This was, and continues to be, an extremely controversial and lucrative business, especially during times of market volatility and elevated trading volume. In the late 2000s and early 2010s knight capital was the largest trader of u.s stocks. They had nearly 20 market share in market making on both the new york stock exchange and the nasdaq exchange at their peak. They had multiple offices in new york, london, singapore, hong kong and many other places.

They were actually one of the few publicly traded market making companies. That's how we know how much money they actually made, which was usually in the hundreds of millions of dollars in profits until 2012.. In that year, night capital lost three quarters of a billion dollars for investors equal to half its market cap. At the time, the reason net trading revenue tanked from 630 million dollars in 2011 to only 50 million dollars in 2012..

High frequency trading is known to be a cyclical business, but this magnitude of a trading loss over the course of the year was unprecedented and it was all caused by one little mistake made by a technician on august 1, 2012. A technician for knight capital was copying. A new piece of trading software to eight different servers that implemented knight's trading strategy. The general purpose that these eight servers implemented was called retail liquidity program and it was in charge of deciding what happens to retail brokerage orders.

There are many different ways that electronic market makers can handle retail order flow. For instance, they can decide to trade against it, providing a better price or equal to the current best market price, or they can send it to one of several different exchange trading routes. The retail liquidity program is the training system that knight used to decide which of these routes. Retail orders are sent to in real time.

On august 1st 2012, a technician for knight was upgrading the retail liquidity program, logic for knight capital on eight servers that it was running on. However, he somehow missed one of the eight servers and left it running the old computer code in some potential outcomes of this situation. This may not have caused any problems, but in this case it changed the functionality of a crucial part of code called powerpig. Powerpeg was a system that put out money losing trades in the market in order to verify that knight's trading algorithms were working properly.

However, the new trading system that knight capital ruled out used the same flag that powerpeg was set to, meaning that powerpeg was triggered at random times during live trading when it wasn't supposed to be the next day when night capital's trading systems went online, live trading, powerpeg Was triggered millions of times the outcome was 4 million stock order, executions in 154 different stocks amounting to nearly 400 million shares traded after 45 minutes. The mistake was noticed and nice trading systems were frozen, but it was not before those 400 million shares had traded and incurred. Substantial trading losses, knights rogue trading systems caused a major disruption in the new york stock exchange stocks that it was trading. One stock that i was trading called wizard software corporation, solid stock, shoot up more than three hundred percent from three and a half dollars a share to fourteen dollars and seventy five cents a share.

Obviously, such an uncontrolled market moving trading frenzy was not profitable for night capital and other high frequency traders were surely picking off night capital's positions the whole time adding to the losses. In the end, the trading company's losses amounted to a staggering 440 million dollars all incurred. In the span of 45 minutes of trading at the time night capital had a market cap of about 1.5 billion dollars, a 440 million loss was roughly equivalent to four to five years of knight's entire company profits. There is no way that the company could bounce back from such a devastating loss within a day night capital stock price, plunged by 75 literally overnight, knight capital had gone from being one of the world's most successful high frequency traders to having its ceo scrambling for emergency Funding just to keep the company afloat, it was a devastating blow.

Four days later, knights management was able to raise 400 million dollars from several investors to try to save the company. As part of the fundraising, the investment bank jefferies paid 125 million dollars to become the company's biggest shareholder. In addition, several other smaller creditors took advantage of knight's position to buy diluted shares in the company. It was a supremely embarrassing time for ceo, thomas joyce.

He had been an outspoken critic of how nasdaq handled facebook's messy ipo the facebook ipo, which happened less than three months before the knight capital debacle, saw multiple technological problems on the nasdaq trades were not going through. There is ambiguous order, confirmation, and after a week, the biggest ipo in tech history at the time saw its share price fall below the initial ipo price. The ceo of knight capital group was a vocal critic of nasdaq's technology and handling of the glitches on the day of the ipo. But after his own trading company suffered possibly the most costly technological mistake in trading history, he himself became the very face of embarrassment.

In december of the same year, knight capital was acquired by getco, llc and merged into a new company called kcg group. Getco llc took over the trading infrastructure and operations of knight capital group and became one of the largest market makers in the world four years after that, kcg group itself was acquired by virtue financial, yet another market making company virtue financial is to this day. One of the biggest market makers in the world and has operations in 36 countries trading over 25 000 different securities is much bigger than night. Capital group was making more than a billion dollars of net profit in recent years, but one thing is for certain: they have not tried to retain any image of the legacy of knight capital, despite how much of their operations may be left over from the company.

Many other trading firms like knight capital, have since also exited the industry. The electronic trading and market making industry is extremely competitive and there has been a huge amount of consolidation in the past decade. For example, the chicago mercantile exchange only lists a small group of nine market makers for the high volume e-mini equity index options. These include options on things like the s p 500 index, with the ability for stronger companies with edge to push out less efficient competitors.

Many market makers have exited the industry in another 10 years. There may be only two or three market makers left whatever the case may be. The story of knight capital group will forever be the most embarrassing and entertaining legacy of one of the biggest market makers that went out of business. Alright, guys that wraps it up.

For this video, if you like the content, make sure to smash that like button and subscribe for future videos, also don't forget to leave a comment saying what you think about night capital's downfall in the meantime. Thank you so much for watching and we'll see you in the next video wall street millennial, signing out.