Although dispirited and bleak, in the backdrop of the bating EUR-USD exchange rate and the mounting Greek Debt Crisis, the New York Stock Exchange began on a fairly low note on May 6th, 2010. Despite a weak start to the trading day, neither the traders and investors nor the analysts augured a tumultuous turn of events, as the stock prices plunged by 1,000 points and the S&P 500 dropped 9%1, all traced to a single gargantuan sell order. However, apart from these intricacies, what remains the most intriguing aspect is the time duration of the stock market crisis- 36 minutes. This trifle time period pillaged trillions of dollars in equity.
As the name suggests, a flash crash is a situation in the financial equity markets wherein rapid and massive stock order withdrawals amplify declines in the share prices. When shares, especially those which are a behemoth in nature, are sold-off in large volumes frequently in the market, prices plummet owing to the demand-supply disequilibrium.
The Flash Crash of 2010, alias the Crash of 2:45 pm, is the biggest flash crash ever witnessed in the history of global capital markets. At about 2:32 pm, the Dow Jones Industrial Average fell more than 1,000 points in ten minutes, an unprecedented plunge never witnessed before. Hundreds of billions of dollars evaporated from the stock prices of prominent companies such as Procter & Gamble and General Electric. The flash crash lasted for a couple of minutes, after which the market started regaining composure and recovered nearly 70 % of the losses conferred. At the end of the trading day, the market closed at 3 % lower.
Flash crashes are known for their high speed, for the market rebounds after plummeting within a matter of minutes. It is clear that the sharp decline and consequent rise in prices can not be accredited to the fundamental value of the stock.
One of the plausible causes attributed was the ‘fat-finger theory’. A fat-finger error occurs when an erroneous computer input that places an order to buy or sell a stock in volumes larger than intended, or the wrong stock or contract, or simply a combination of both, in a financial market. According to this theory, traders placed an inadvertently large sell order for the P&G stock, actuating massive computer algorithmic trading to dump the stock. However, this theory was considered wrong when analysts figured that P&G’s price fell due to a decline in the E-Mini S&P futures contracts.
Another reason put forth was the impact of high-frequency traders, who cause or exacerbate the flash crash. These traders use trading algorithms to perform large transactions at very high speeds. In addition, investors can also purposely use algorithms to partake in illegal trades such as spoofing. Spoofing may result in algorithms being programmed to put in bogus and spurious sales. Traders will put in an order to sell sizeable market stocks, but pull the order right before it is completed. By simply placing such a large sell order, prices are driven down due to a rise in supply for a given demand, and the traders will then buy at the reduced price. With algorithms, this process has become very effective, thereby enhancing volatility in the market. Due to the large losses incurred, this has been declared illegal, leaving space for hefty fines, barred activity in the market, and in the worst case, imprisonment.
