The Flash Crash— Solved!

by wjw on October 2, 2010

Friend of the blog Ralf sent me a link to an article in which it is claimed that the SEC/CFTC investigation into May’s Flash Crash has finally come up with the culprit— naturally, an automated trading program.

In the 104-page report, staff members at Securities and Exchange Commission and the Commodity Futures Trading Commission said an unnamed investor used a trading algorithm to sell orders for futures contracts called E-Minis, which traders use to bet on the future performance of stocks in the S&P 500 index.

The contracts were sold quickly and in large numbers, according to the report, on a day when the market was already under stress due to concerns about the European debt crisis.

The selling was initially absorbed by “high frequency traders” and other buyers, the report said. But the algorithm responded to an rise in trading volume by increasing the number of E-Mini sell orders it was feeding into the market.

“What happened next is best described in terms of two liquidity crises — one at the broad index level in the E-Mini, the other with respect to individual stocks,” the report said.

In other words, the lack of buyers and the rapid selling of E-Mini futures contracts began to affect the underlying stocks and the broader stock indexes.

As a result, the Dow Jones industrial average plunged nearly 1,000 points, briefly erasing $1 trillion in market value, before regaining much of the lost ground to close lower. It was the largest one-day drop on record.

Oddly enough the report makes no recommendations for solving this little bug, possibly because as long as you let automated trading algorithms trade on the market, this kind of shit is inevitably going to happen.  (A trillion dollars erased?  A mere bagatelle, m’sieur!)

The report doesn’t name the culprit (Gee, if my algorithm was so dimwitted as to drop $4 billion in sell orders on a weak market, I’d rather remain anonymous, too!).  But the firm responsible is widely suspected to be Waddell & Reed, a trading firm operated out of Overland Park, KS.

Kansas?  There’s no place like home!  There’s no place like home!

TEngland October 4, 2010 at 12:02 am

After living in KC Missouri and Kansas, I’m realizing there is a lot of tech hidden amongst the corn stalks. And tall corn makes a great place to hide.

John Appel October 5, 2010 at 2:44 pm

What’s amusing (to me, at least) is that at least one financial industry publication has been whining for several weeks that it’s all really the SEC’s fault, and that the poor innocent HFTs (High Frequency Traders) are being made the scapegoats.

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