On the first anniversary of the Flash Crash, the huge single day disruption and lightning-quick recovery that rattled the stock market, we still don’t know exactly what caused it or whether enough is being done to prevent a recurrence. That’s reason to worry.
Participants in the capital markets blame the Flash Crash on everything from quirks in automated trading systems to the fragmentation of rules governing trades and markets. Regulators appear to have difficulty distinguishing the muddled relationships and subtleties among asset classes and markets. High frequency trading continues at even faster speeds, markets are becoming more volatile, and the specter of another crash – with the potential for far more devastating effects on the global economy – remains.
The Commodities Futures Trading Commission and the SEC, in a joint report last fall, officially blamed the Flash Crash on a single order by a mutual fund to sell futures contracts on the afternoon of May 6, 2010. That’s like the Warren Commission ruling that President Kennedy was assassinated by a “magic bullet” delivered by a lone gunman. Most market participants don’t buy the official government assessment.
Alison Crosthwait, director of global trading research for Instinet, an electronic trading platform, says the sell order that the SEC and CFTC claim to be the magic bullet was not abnormally large and could not have caused such a significant ripple in trading.
CME, the derivatives marketplace where the order was placed, reports that the “E-mini” futures contract in question accounted for just 1.3 percent of the total volume of such contracts on May 6, 2010. Plus, that relatively minor trade was completed in about 20 minutes, with more than half the orders executed as the market rallied, and not when it first crashed, according to the CME.
Instinet’s Crosthwait notes that the CME has stop-gap functions in place that force any trader to take a five second breather after a certain degree of price movement. “This pause provided ample time for market participants to consider their positions and return to the market or not depending on the conclusion they reached,” she said.
The biggest problem: The Flash Crash displayed the interconnected nature of today’s markets but regulators have yet to acknowledge or address this aspect of today’s modern exchanges. Order-driven markets can experience huge disruptions regardless of where the orders take place. The Flash Crash saw rapidly falling stock prices stemming from orders taken in a derivatives market.
On Thursday, the day before the first anniversary, the Dow Jones Industrial Average dropped more than 139 points, or 1.1 percent, and it has fallen nearly 3 percent after reaching a 12-month high on Monday.
There has been much talk in the last year about the need for new rules but very little action. Whatever measures regulators take, one thing is clear: Nobody wants another Flash Crash anniversary. One is enough.