* Huge volume in small stocks roil 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
(Adds Knight statement, recasts lead)
By Caroline Valetkevitch and Chuck Mikolajczak
NEW YORK, Aug 1 A rush of unusually high volume ripped through dozens of stocks on the New York Stock Exchange in early trading on Wednesday due to a technology error at market maker Knight Capital, becoming the latest in a series of high-profile mishaps that have damaged investor confidence in public markets.
Heavy computer-based trading erupted at the open, diverting attention from the day's news, and prompting the NYSE to review trades in 140 different issues after the issue caused a trading halt in a handful of New York Stock Exchange-listed stocks.
"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 Capital (KCG.N), one of the largest U.S. market makers, said in a statement.
Knight said the problem prompted it to tell clients to send orders to other firms. Knight officials were not available for further comment.
As a market maker, Knight stands ready to buy and sell shares at quoted prices, adding to market liquidity.
The trading glitches follow a series of events that have hurt retail investors' confidence in the market, including the botched Facebook initial public offering, the 2010 "flash crash," and the failed public offering of BATS Global Markets.
On Wednesday, a surge of orders were executed at the start of trading, disrupting normal trading activity.
Several market participants said the source of the problem may have been large orders meant to be filled throughout the day that were instead executed in a shorter time frame, with some saying the orders came in the first 15 minutes of trading.
The broader market was little changed, with the Standard & Poor's 500 index .SPX .INX up 0.25 percent, as the trading glitch quickly became the focus for traders.
"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.
Shares of Knight Capital plunged 21.4 percent to $8.13, after hitting a seven-year low of $7.60 a share.
It was unclear whether the problem was related to NYSE's new program, launched on Wednesday, that gives retail traders slightly better prices than others in the market. [ID:nL2E8I5C4N]
The program is seen as an effort to induce retail investors to trade away from mostly off-exchange electronic "wholesalers."
The NYSE's Retail Liquidity Program is a direct challenge to Knight and other market makers that typically get a first look at the highly coveted orders from individual traders, known as retailers, and it is meant to reclaim some market share NYSE lost over the last decade.
A spokesperson for NYSE Euronext NYX.N declined to comment, but a source familiar with the matter said the exchange had not experienced any issues with its systems.
"It appears to be dozens if not hundreds of stocks that have
(seen) extremely high volume and extremely rapid movement," said Joe Saluzzi, co-manager of trading at Themis Trading in Chatham, New Jersey.
The volatility caused pauses in trading for five stocks, which appear unrelated: Corelogic Inc (CLGX.N), China Cord Blood Corp (CO.N), Kronos Worldwide (KRO.N), Trinity Industries (TRN.N) and Molycorp MCP.N.
Trading in those names was much heavier than normal. Molycorp traded more than 5.7 million shares in the first 45 minutes of trading. The stock usually averages about 2.65 million shares daily, and it was one of the stocks halted due to excessive volatility. The stock traded between a range of $17.50 and $14.35 on the session.
Unusual volume was seen in a disparate group of stocks, including Lithia Motors (LAD.N), which already had seen trading volume of 4.3 million shares. The stock usually trades about 95,000 shares daily.
Among other stocks, Protective Life PL.N had already traded more than 10 times its usual volume, and Juniper Networks JPNR.N has already seen six times its usual daily volume.
(Reporting by Caroline Valetkevitch, Angela Moon, John McCrank, Anna Louie Sussman and Chuck Mikolajczak; Editing by James Dalgleish and Leslie Adler)
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