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Trading plummets at Knight Capital

September 25, 2012: 1:17 PM ET

Following trading glitch, high frequency traders took their business elsewhere fast.

FORTUNE - Could Knight Capital's $440 million trading glitch be making the market a little bit fairer?

In August, the volume of trades executed by Knight Match, a system favored by high frequency traders, plunged 44% from the month before. The drop followed a programing glitch that caused Knight's computers to execute millions of faulty buy and sell orders. The glitch ended up costing Knight Capital Group (KCG) $440 million and nearly sent the firm into bankruptcy.

Knight was saved by a hastily assembled $400 million from a consortium of investors, but it appears the damage to Knight's reputation with customers, particularly high frequency traders, will take longer to repair. Knight says the volume numbers, which were compiled by stock market and technology research firm Tabb Group, exclude the trading glitch, which happened on August 1st. Knight was forced to shut down its systems for part of that day. The volume drop shows that traders shied away from Knight longer than just in the days following the trading glitch. A Knight spokeswoman says the company won't comment on whether trading volumes rebounded in September until early next month.

MORE: Why Knight lost $440 million in 45 minutes

Stock trading was relatively slow in August in general, especially compared to a year ago, when a credit downgrade of U.S. Treasury bonds by Standard & Poors caused the market to drop. Overall, stock trading was down just under 10% in August compared to July. Still, it seems, Knight's trading glitch and others like it have knocked some of the momentum out of high frequency trading, which has become a larger, and more controversial, part of the market in the past few years. By comparison, the New York Stock Exchange recently said a system that was launched in August to draw orders away from trading venues used by high frequency traders is gaining in volume.

By some estimates high frequency traders make up two-thirds of all stock market trading. Last week, the Senate held a hearing on high frequency trading. One of the issues discussed was whether exchanges and trading venues like Knight give preferential treatment to high frequency traders over individuals or other traders.

Besides Knight Match, Knight also has a market making business that completes orders for electronic brokerage firms and others. It also has a system that allows institutional investors to trade with each other off the exchange. All told, Knight said its overall trading volume was down by just over a third.

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But Knight Match is a so-called dark pool, which is the platform run by the company that is most favored by high frequency traders, who, like Knight, use computer programs to buy and sell stocks in milliseconds. So-called dark pools have become a fixture in the way stocks are traded. Dark pools allow traders to buying and sell stocks off exchanges without displaying their orders. Trades on dark pools only get reported once they have been completed. Exchanges, on the other hand, display all buy and sell orders when they are placed, ahead of the actual trades being completed.

Six of the dark pools tracked by Tabb had double digit trading volume decreases in August. Knight fared significantly worse than rivals. Nonetheless, dark pools aren't going away anytime soon. According to the Tabb data, despite the drop, nearly 14% of all trades took place in dark pools last month.

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About This Author
Stephen Gandel
Stephen Gandel

Stephen Gandel has covered Wall Street and investing for over 15 years. He joins Fortune from sister publication TIME, where he was a senior business writer and lead blogger for The Curious Capitalist. He has also held positions at Money and Crain's New York Business. Stephen is a four-time winner of the Henry R. Luce Award. His work has also been recognized by the National Association of Real Estate Editors, the New York State Society of CPA and the Association of Area Business Publications. He is a graduate of Washington University, and lives in Brooklyn with his wife and two children.

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