* Huge volume in small stocks roils markets
* Knight cites "technology issue" in market-making unit
* Knight's stock plunges, hits 7-year low
* Knight advises market-making clients to execute elsewhere
* NYSE to cancel trades in six stocks (Edits wording in 5th paragraph)
By Caroline Valetkevitch and Chuck Mikolajczak
NEW YORK, Aug 1 (Reuters) - A technology breakdown at a major trading firm roiled the prices of 140 stocks listed on the New York Stock Exchange on Wednesday, undermining fragile investor confidence in the stability of U.S. stock markets.
The problems at Knight Capital Group Inc, one of the largest firms that buys and sells stocks to provide liquidity to the markets, emerged at the beginning of trading.
Heavy computer-based trading caused a rush of orders for dozens of stocks, ranging from well-known bellwethers like General Electric to tiny Wizzard Software Corp, whose shares soared to $14.76 after closing the previous day at $3.50. The NYSE has canceled trades in six particularly volatile issues.
The trading glitches are the latest in a series of market snafus that have hurt retail investors' confidence, including the botched Facebook initial public offering, the 2010 "flash crash" in which nearly $1 trillion in market value disappeared in minutes, and the failed public offering of BATS Global Markets, a rival to the NYSE and the Nasdaq.
The exact nature of the technology issues were unclear. The the magnitude and fallout for Knight, which was forced to tell clients to send orders elsewhere, and for the broader market were also unknown. Knight's stock plunged nearly 33 percent to $6.94, a nine-year closing low for the stock.
Knight Capital issued a terse statement acknowledging the trading errors, but company officials were not available for further comment.
"This morning, a technology issue occurred in Knight's market-making unit related to the routing of shares of approximately 150 stocks to the NYSE," Knight said in the statement.
Observers said the problem highlighted the weaknesses in the market that remain two years after the Flash Crash.
"The structure that we have in place is so complicated and intertwined, that all of these entanglements have created real issues in the marketplace," said Christopher Nagy, a consultant to exchanges and brokerages.
"Today it's Knight. Tomorrow, who's it going to be? And the day after that, who's it going to be? The fixes that we're putting in the marketplace are just not fixing things."
Trading glitches are nothing new, but years ago there was more accountability when the mistakes were caused by individuals, said one discount brokerage executive who declined to be named.
The executive recalled a situation in the 1990s where a clerk accidentally submitted a trade for $2 million worth of the Nasdaq 100 tracking stock, instead of 2 million shares, and was fired the next day.
But the May 2010 Flash Crash, as well as the Facebook IPO debacle suggest there is less accountability now. "If you had a program where firms were put in a penalty box when these things happen, you probably would see people be more careful," the executive said.
SOME STOCKS SOAR WHILE OTHERS SLUMP
Heavy buy orders in some stocks sent prices soaring, while others plunged. Many of the names were lesser-known issues such as Molycorp Inc, a stock that usually averages about 2.65 million shares daily but which saw volume of more than 5.7 million shares in the first 45 minutes of trading, bouncing between $17.50 and $14.35 in that period.
The mood at the Knight Capital booth on the NYSE trading floor was somber, with worried traders taking numerous phone calls as well as answering questions from NYSE officials who were making inquiries on the floor.
Many on the floor were aware that the problematic trades were coming from Knight.
At another spot on the floor, a group of Goldman Sachs traders huddled together, talking about what would be the effect on trades made and what trades would be canceled.
As a market maker, Knight stands ready to buy and sell shares at quoted prices, adding to market liquidity. The company reported revenue of $289.3 million in the second quarter.
Knight's bread-and-butter is handling trade executions in small-cap stocks for other brokerage firms. When Chief Executive Tom Joyce arrived in mid-2002, the market-maker was struggling against low trading volumes and high payouts made to attract business from discount brokers.
In his 10 years at Jersey City, New Jersey-based Knight, alongside back-office operations of major firms such as Goldman Sachs Group, Joyce made aggressive moves into hedge funds, derivatives and other areas, many of which fizzled.
Joyce, whose laid-back demeanor distinguishes him from many more volatile equity stock traders, spent 15 years at Merrill Lynch & Co. While many of his colleagues have moved into wealth management, Joyce remained in equity trading, building a sizeable stake in the company during that time.
As of April 2, Joyce owned more than 1.2 million shares of Knight Capital, with a market value of nearly $16 million - a stake now worth about $8.5 million.
For Knight investors, the trading glitch will be hard to shake off. "The fact that Knight told people to go trade somewhere else is I am sure unprecedented in the industry," said Dave Nadig, director of research at IndexUniverse, which researches ETFs.
That said, the markets remained stable - the broader Standard & Poor's 500 index ended down 0.3 percent.
A spokesman for the U.S. Securities and Exchange Commission said the agency was "closely monitoring the situation" and is in "continuous contact with the NYSE and other market participants."
Several market participants said the large volume of orders that roiled trade may have been intended to be filled throughout the day but instead were executed in the opening minutes of trading.
The NYSE said in the afternoon that it would cancel trades in six different stocks, including Wizzard, China Cord Blood Corp, E-House Holdings, American Reprographics and Quicksilver Resources.
Trades executed at 30 percent higher or lower than the opening price will be canceled, NYSE Euronext said in a statement. No trades in any of the other affected stocks will be canceled, the NYSE said later.
A source familiar with the matter said the exchange had not experienced any issues with its systems or its normal circuit breakers that halt excessively volatile stocks.
In early trade, however, the environment was described as chaotic.
"That has disrupted all the normal activities - stocks are moving all over the place, they are weird, they are trading like millions of shares, 100 shares at a time, so something went haywire somewhere," Stephen Massocca, managing director, Wedbush Morgan in San Francisco, said in the first hour of trading.
The volatility caused pauses in trading in five stocks: Corelogic Inc, China Cord Blood Corp, Kronos Worldwide , Trinity Industries and Molycorp. Representatives from the companies declined comment.
"This is people's money. This is 401(k)s. Grandma's mutual fund is now being whipped around by algos that don't even understand what they're doing," said Joe Saluzzi, co-manager of trading at Themis Trading in Chatham, New Jersey.
"How many more dollars now have to come out of the market because people don't trust it?" (Additional reporting by Angela Moon, Rodrigo Campos, Jessica Toonkel, Jed Horowitz, Brendan McDermid, John McCrank and Anna Louie Sussman in New York and Sarah Lynch in Washington; Editing by David Gaffen, Edward Tobin and Leslie Adler)
The Morning Email helps you start your workday with everything you need to know: breaking news, entertainment and a dash of fun. Learn more