The Stock Market Flash Crash Explained: Capital Markets & Dow Jones (2010)

• published: 24 Dec 2014
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A flash crash is a very rapid, deep, and volatile fall in security prices occurring within an extremely short time period. A flash crash frequently stems from trades executed by black-box trading, combined with high-frequency trading, whose speed and interconnectedness can result in the loss and recovery of billions of dollars in a matter of minutes and seconds. This type of event occurred on 6 May 2010 when a $4.1 billion trade on the NYSE resulted in a loss to the Dow Jones Industrial Average of over 1000 points and then a rise to approximately previous value, all over about fifteen minutes. The mechanism causing the event has been heavily researched and is in dispute. Two notable flash crashes have occurred as of August 2013: May 6, 2010, Flash Crash April 23, 2013, Flash Crash In October 2013 a flash crash occurred on the Singapore Exchange which wiped out $6.9 billion in capitalization and saw some stocks lose up to 87 percent of their value. The crash resulted in new regulations being announced in August 2014. Minimum trading prices of 0.20 cents per share would be introduced, short positions would be required to be reported, and a 5 percent collateral levy implemented. The exchange said the measures were to curb excessive speculation and potential share price manipulation. CME Group, a large futures exchange, stated that, insofar as stock index futures traded on CME Group were concerned, its investigation found no evidence that high-frequency trading played a role, and in fact concluded that automated trading had contributed to market stability during the period of the crash.[21] Others speculate that an intermarket sweep order may have played a role in triggering the crash.[22] The fat-finger theory: In the immediate aftermath of the plunge, several reports indicated that the event may have been triggered by a fat-finger trade, an inadvertent large "sell order" for Procter & Gamble stock, inciting massive algorithmic trading orders to dump the stock; however, this theory was quickly disproved after it was determined that Procter and Gamble's decline occurred after a significant decline in the E-mini S&P; 500 Futures contracts.[23][24][25] The "fat-finger trade" hypothesis was also disproved when it was determined that existing CME Group and ICE safeguards would have prevented such an error.[26] Impact of high frequency traders: Regulators found HFT's exacerbated price declines. As noted above, regulators found that high frequency traders exacerbated price declines. Regulators determined that high frequency traders sold aggressively to eliminate their positions and withdrew from the markets in the face of uncertainty.[10][11][12][13] A July, 2011 report by the International Organization of Securities Commissions (IOSCO), an international body of securities regulators, concluded that while "algorithms and HFT technology have been used by market participants to manage their trading and risk, their usage was also clearly a contributing factor in the flash crash event of May 6, 2010."[27][28] Other theories postulate that the actions of high frequency traders (HFTs) were the underlying cause of the flash crash. One hypothesis, based on the analysis of bid-offer data by Nanex, Llc., is that HFTs send non-executable orders (orders that are outside the bid-offer spread) to exchanges in batches. Though the purpose of these orders is unknown, some experts speculate that their purpose is to increase noise, clog exchanges, and outwit competitors.[29] However, other experts believe that deliberate market manipulation is unlikely because there is no practical way in which the HFTs can profit from these orders, and it is more likely that these orders are designed to test latency times and to detect early price trends.[30] Whatever the reasons behind the possible existence of these orders, this theory postulates that they exacerbated the crash by overloading the exchanges on May 6.[29][30] On September 3, 2010 the regulators probing the crash concluded: "that quote-stuffing – placing and then almost immediately cancelling large numbers of rapid-fire orders to buy or sell stocks – was not a “major factor” in the turmoil."[31] Some have put forth the theory High-frequency trading actually has been a major factor in minimizing and reversing the flash crash. http://en.wikipedia.org/wiki/Flash_crash