In the August 30 issue of Barron's magazine, columnist Jim McTague entitled his essay, "Was the Flash Crash Rigged?" The term "flash crash" refers to the sudden drop in stock prices in a short period of time on May 6, 2010. Mary L. Schapiro, Chairman of the U.S. Securities and Exchange Commission in testimony before Congress on May 11, 2010 gave the chronology of trading as follows:
On Thursday May 6, the stock market Dow Jones Industrial Average [DJIA] declining 161 points, or approximately 1.5.% by 2:00pm [ET]. Shortly after 2:30 pm, however, the market decline began to steepen and by 2:42 pm, the DJIA was at 10,445.84, representing a decline of approximately 3.9%. The DJIA then suddenly dropped an additional 573.27 points, representing an additional 5.49% decline in just five minutes of trading, hitting 9,872.57 at 2.47 pm, for a total drop of 9.16 percent from the previous day's close [insufficient to trigger a circuit breaker trading halt].
Similar declines were seen in the S&P index and the CBOE Volatility Index [VIX], a widely followed measure of market volatility sometimes known as the "fear index", climbed above 40, a level not reached in over a year.
As quickly as the market dropped, it suddenly and dramatically reversed itself, recovering 545 points in approximately a minute and a half to 10,415.65. By 3:00pm, the total daily decline in the DJIA had been reduced to 463.05 points [4.26%]. The DJIA ended the day at 10,520.32, down a total of 3347.80 or 3.2% from the prior day's close. This represented a significant down day for the markets, but the closing numbers belied the markets' dramatic moves down and then up during approximately 20 minutes of trading in mid-afternoon. In addition, many individual securities experienced much larger swings in their trading activity. For example, two DJIA components--Procter&Gamble and 3M--experienced declines of approximately 37 and 21% respectively. In addition, certain stocks were executed at absurdly low prices, such as one stock which opened above $40, was traded at one point at a penny, and then closed the day above $40.
In addition, a large number of Exchange Traded Funds [ETFs] traded for short periods of time with massive intraday price swings. The shares of more than 25% of all ETFs experienced temporary price declines of more than 50 % from their 2 pm market prices.
At a later point in her testimony, she said, "We believe that it is critical to understand the causes and effects of this event so that we can work to ensue that it does not occur again". Although too early to draw conclusions, the chairman pointed to a focus on:
1. Absence of professional liquidity providers.
2. Disparate exchange practices.
3. Other factors including, thinly traded stocks and ETFs, stop loss market orders in an illiquid market that triggered automated selling that resulted in executions at aberrant prices and finally so called stub orders that trigger at or near a penny.
4, The complexity of the new National Market Structure including the multiplicity of trading centers , highly automated trading systems and high-frequency trading.
In spite of circuit breakers in place, the chairman pointed out that."none of the NYSE Rule 80B thresholds was triggered on May 6, despite the severe disruption in trading in many stocks". What was worse, some erroneous trades were cancelled and others were not causing great consternation.
In summary, the SEC like all of us who trade, knows what happened and promises to find out why. In the meantime, McTague in his article suspects that high speed traders pay the exchanges hundreds of thousands of dollars a month for direct feeds to their trading floors which allow them to see information headed for the Consolidated Quote System in advance. The CQS is the modern version of the "tape" that the stock-buying public sees. It only takes a few mili-seconds and as McTague points out, you have the modern Wall Street version of The Sting.
The real bottom line is that until we have a plausable diagnosis of the cause of the flash crahs and can establish order and trust to our markets, they are not to be trusted. Progression of this situation will result in instability and possibly chaos.
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