Market Regulation Services Inc. (RS) has issued a bulletin warning about the added risks of using algorithmic trading systems, and spelling out the supervisory obligations of firms using them.

RS suggests that orders entered through an automatic system present heightened risks to both the integrity of the markets and to the financial position of the dealer. “Algorithmic trading systems provide the ability to enter a high volume of orders on one or more marketplaces in a short period of time. As such, algorithmic trading systems can disrupt a fair and orderly market if such systems ‘malfunction’,” it says.

With that in mind, RS says it expects that firms will ensure that each algorithmic trading system has been adequately tested assuming various market conditions prior to using it. It also expects firms that use algorithmic trading systems will have supervisory policies and procedures that are adequate to prevent and detect violations of the trading rules, as well as safeguards to prevent the entry and execution of “unreasonable” orders.

Additionally, the notice points out the limitations on RS’ ability to intervene to vary or cancel trades arising from a malfunctioning algorithmic trading system. It says that RS will not ordinarily vary or cancel orders resulting from errors, including orders generated by a “runaway” algorithmic trading system. Also, orders or trades that impact market volatility or quality will not be cancelled or varied by RS.