“Flash crash” report shows how, er, crashes happen

October 4, 2010

The “flash crash,” or something like it, could happen again. There’s no real blame in a report last week from the Securities and Exchange Commission and the Commodity Futures Trading Commission on the sudden plunge in stock prices on May 6. Some fixes can be made. The broader lesson is that markets will always have tipping points.

Waddell & Reed’s $4.1 billion computerized sale of E-Mini S&P 500 futures in the middle of that spring afternoon certainly hit with a thud. Sales were programed at the rate of 9 percent of the total market volume in the previous minute, with no adjustments for price or time, parameters that often are applied to such trades.

With sentiment already negative, the selling pressure soon spread to other index contracts, exchange-traded funds, individual stocks and other markets. The charts in the regulators’ report vividly depict the precipitous fall and, in a partial vindication of market mechanisms, the almost equally rapid recovery.

Once it started, the loss of liquidity snowballed. Among other things, many computer programs stopped buying. Market-makers, rarely holders of big long or short positions, found themselves in breach of risk limits and were unable to continue trading. Some firms’ own systems imposed trading breaks amid the plunge. The official pauses on some but not all markets confused the situation. And firms whose systems compare data feeds for integrity found flaws and shut trading down, too.

One remedial option being tested is circuit-breakers that apply across all the venues where the same instruments trade. Technology also needs a look. The New York Stock Exchange inadvertently added spice to the chaos because, amid high volume, data on 1,665 stocks were delayed far longer than information on other stocks because they were traded on servers awaiting upgrades. In a related vein, there’s room for a close look at some of the practices of lightning-fast computerized traders. Waddell’s selling program surely needs a rewrite, too.

But in the end, even extreme volatility can’t be legislated away. As the regulators put it, May 6 brought a “general feeling of unease” and, once prices started sliding, some people “feared the occurrence of a cataclysmic event of which they were not yet aware.” It’s only human to join a herd escaping a perceived threat. As long as people trade, or program computers to do so, there will be combinations of events that conspire to start stampedes.

Comments

No need for fancy IT solution.

Tobin tax, that’ll sort it.

Posted by Dafydd | Report as abusive
 

The stock market is being manipulated or even hacked. You want to see who caused the flash crash look at the trades coming from Russia and/or China that day. What no one wants to admit is… just like any computer network, the nyse can be compromised. I believe this is a kind of cyber and economic warfare. This will keep happening and the press will keep blaming it on high-frequency trading. This has yet to be verified and according to this report was not the main cause of the flash crash.

Posted by thedots | Report as abusive
 

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