The Crash Erased $1 Trillion dollars with $4 Billion dollars of Trade.
Algorithmic trading
http://en.wikipedia.org/wiki/Algorithmic_trading
Automated Trading software robots have artificial intelligence algorithms programmed (machine learning) into them. they make up new rules independently as they go along, evolving like DNA, but in the digital world.
A human would not sell stock down $3, $5, or $10 in milliseconds; the brakes have to be applied in certain circumstances because the consequences are too great on investors, retirement plans, pension funds, money to create new jobs etc.
Dow Jones Industrial Average plummet nearly 1,000 points in 15 minutes — erasing more than $1 trillion in market value — before it rebounded almost as quickly. Still unclear: What caused the erratic crash. Here are the 5 leading theories:
1. A computer glitch
Some analysts trace the crash to a possible error in a Citigroup computer that performs complex electronic or “high frequency” trades, and may have triggered a “huge anomalous surge in selling” in a Chicago-based automated trade system, reports The New York Times. When traders saw this surge, the theory goes, they joined in the spree.
2. The world’s most expensive typo
Rumors are circulating that an errant trader might have wiped billions off the stock market by typing “$16 billion” instead of “$16 million” in a trade involving Proctor and Gamble, reports The New York Daily News. The seemingly massive sale sparked an equally colossal sell off, with the multinational’s share price dropping 37 percent in a matter of minutes. Financial insiders call this sort of typo trouble a “fat finger trade.”
3. The Greek riots
Lost in the drama of the 1,000-point drop was the fact that the Dow had already fallen 631 points in the past three days on concerns over the crisis in Europe. As rioting in Greece continued into Thursday, jittery traders — worried that Europe’s unfolding debt crisis would spread to U.S. markets — may have gone on a selling spree.
4. Unscrupulous securities traders
The SEC is also examining the possibility that securities traders “accidentally or maliciously” triggered the stock market crash by artificially inflating the number of sales. It has joined forces with the Commodities Futures Trading Commission to probe “unusual trading” on Thursday afternoon.
5. Cyber-terrorism
Is it possible that cyber-terrorists — inspired (or not) by the Times Square bomber — attempted to undermine American interests via its stock market? “Rogue nations and terrorist organisations have been developing their ‘cyber warfare’ capabilities for some time now,” says Michael Snyder at Benzinga. “We have been repeatedly warned that someday we will see an “Internet 9/11.”
The real cause
A single stock trade made in Kansas led to the $1 trillion loss in stock market value on Wall Street, a long-anticipated report released yesterday by federal regulators has found.
That ill-fated trade led to a 20-minute chain of events last May 6 that sent stocks plummeting and wreaked havoc on swooning US exchanges and nail-biting investors – before markets mounted a just- as-fast rapid-fire rebound, according to the 104-page report by the Securities and Exchange Commission and the Commodities and Futures Trading Commission.
Chain reaction
The impact and ramifications of quant trading are widespread, but ultimately unclear. A study, commissioned by the Foresight programme, found that quant trading helped to reduce dealing costs and improve liquidity, and did not harm overall market efficiency. In fact, it found that HFT and quant trading have “generally improved market quality”.
However, it did highlight one important concern, known in the trade as self-reinforcing feedback loops. This essentially means a small trigger leading to a series of similar events, each amplifying the last, until the overall impact is significant.
Imagine a share falls in value, triggering a sale on one quant program, pushing the share price even lower. This in turn triggers a sale on another program, pushing the price lower still, and so on and so on. The problem is exacerbated by the fact that many programs run on the same formulae, and so are piling in and out of the same stocks.
Nowhere is this better demonstrated than by the so-called Flash Crash of May last year, when the US stock market plummeted 700 points in less than five minutes, wiping out about $800bn (£517bn). When the auto-pilot switches were turned off and the systems overridden, order was restored and the market bounced back within half an hour.
Because of the velocity of the crash and rebound – the steepest drop happened over just three minutes, from 2:43 p.m. to 2:46 p.m., amped up by computer-driven technology – the incredible afternoon of trading has been called a flash crash.
According to the report, a large mutual fund company, believed to be Overland, Kan.-based Waddell & Reed Financial, submitted an automated order to unload 75,000 contracts, worth $4.1 billion, of so-called e-minis – securities that mimic the performance of the Standard & Poor’s 500 Index.
Waddell is not believed to be under investigation for any wrongdoing. The computer-driven trade did not factor in price or time of day, and, given lingering worries over a potential debt crisis in Europe and a dwindling number of buyers at that relatively late point in the trading day, it sparked a dramatic cratering of stock values.
“This was a very unfortunate selection at the time, when markets were already under stress,” said one regulator, speaking on background.
“The execution of this sell program resulted in the largest net change in daily position of any trader in the e-mini since the beginning of the year,” the report read.
Regulators say that many changes to how such electronic trades are executed have already been implemented, and universal halts in stocks have been introduced to address the flash crash and prevent others in the future.
The impact of the e- mini trade was made worse by other automated and so- called high-frequency trades, while “fundamental buyers” fled the market,accelerating the downward spiral in the stock market from 2:32 p.m. to 3 p.m., according to the report.
That volatile environment led to a number of shares getting whipsawed, including those of Procter & Gamble, and Black Rock’s electronically- traded notes iShares Trust, which were hammered be fore bouncing back.
And making matters worse, electronic circuit breakers in certain stocks weren’t universally applied across different exchanges.
The regulators’ report uncovered a number of weaknesses in how the computer- based exchanges communicate, particularly during times of chaos.
“Market participants need to use automated systems to keep up with speed, [but] those automated systems can’t trade when something dramatic happens,” said the regulator.
The CFTC and SEC have been roundly criticized for being unable to pinpoint the cause of the crash more quickly.
“The [regulators] did a thorough and complete analysis, but almost five months is an extraordinarily long time to wait,” said Baruch College’s Bernard Donefer.
Wall street’s monster Linux Supercomputer clusters
One analyst writes:
High Frequency Trading stands at the pinnacle of culprits for the 1,000 point Dow drop. From their findings: “While analyzing HFT (High Frequency Trading) quote counts, we were shocked to find cases where one exchange was sending an extremely high number of quotes for one stock in a single second: as high as 5,000 quotes in 1 second!
During May 6, there were hundreds of times that a single stock had over 1,000 quotes from one exchange in a single second. Even more disturbing, there doesn’t seem to be any economic justification for this. In many of the cases, the bid/offer is well outside the National Best Bid/Offer (NBBO).
We decided to analyze a handful of these cases in detail and graphed the sequential bid/offers to better understand them. What we discovered was a manipulative device with destabilizing effect.” In other words: enough with all the bullshit about HFT as a liquidity provider mechanism: in reality this is just a facade for the most insidious, computerized market manipulative device ever created.
Conclusion: “What benefit could there be to whomever is generating these extremely high quote rates? After thoughtful analysis, we can only think of one. Competition between HFT systems today has reached the point where microseconds matter. Any edge one has to process information faster than a competitor makes all the difference in this game.
If you could generate a large number of quotes that your competitors have to process, but you can ignore since you generated them, you gain valuable processing time. This is an extremely disturbing development, because as more HFT systems start doing this, it is only a matter of time before quote-stuffing shuts down the entire market from congestion.
Dear Senator Menendez, The Flash Crash Wiped Out $1 Trillion In Wealth On Thursday – Fix It
(The following post is an actual letter sent from an NYSE floor trader to New Jersey Senator Robert Menendez. The author prefers to remain anonymous.)
Senator Robert Menendez,
I have worked as a broker on the floor of the New York Stock Exchange and over the last 8-10 years I have seen one of the most dramatic changes to an industry that anyone has seen – from a pen and paper open outcry system to a market that is almost completely reliant on computer programs. Stock trading has become lighting fast, which I think is harmful to our market and our economy as a whole.
To say technology has gotten ahead of the regulators is an understatement. While lots of time and energy has been spent shaping the financial reform bill in Congress, I do not see anything in the legislation that addresses what happened this past Thursday: the Dow Jones traded down almost 1000 points in just a few minutes, wiping out $1 trillion in wealth, and some blue-chip stocks traded as low as 1 cent.
One of the main points I want to stress is that this past Thursday there was not an error, a “fat finger”, or a system malfunction that caused this huge sell-off. This is just how today’s market is structured, and it can and will happen again if nothing is changed. There needs to be a uniform policy in place that all the exchanges follow, such as individual stock circuit breakers, which the NYSE already has in place.
The NYSE for years has had a system to “slow down” trading during extreme market volatility; this slow down is called a Liquidity Replenishment Point or LRP. The idea is for the NYSE, during extremely volatile times, to give the rest of the market an opportunity to step in, buy stock, and stop the sudden free-fall.
During this 30-90 second period, the computer programs wait to replenish while humans step in to find the right price to trade a block. Then the trading goes back to normal. Common sense shows this is the right thing to do.
None of the wild price “aberrations” in stocks such as in PG, ACN, & MMM traded on the NYSE floor; they all traded on completely electronic exchanges such as Nasdaq, Direct Edge, & BATS. The problem is, unfortunately, that none of the other electronic exchanges have to follow the NYSE lead and slow down during this extreme volatility.
Sell orders which were sent to these other exchanges had very little liquidity and very light bids to interact with, which in turn drove the stocks down. Technology has come a very long way in the past 8-10 years, but it has gotten to a point where enough is enough. Computer programs and algorithms do make sense at times when stocks are trading smoothly and there is little to no volatility, but there needs to be times when humans come in to the picture and provide an orderly market.
The argument on the other side coming from Nasdaq is that the NYSE model of going slow is in fact what caused the sell-off in stocks. However, out of the 281 stocks Nasdaq canceled trades in, 193 of them were ETF’s. The NYSE does not trade ETF’s, so there is no way the slow market is what impacted them. Further, the NYSE did not have to cancel ANY trades.
A human would not sell stock down $3, $5, or $10 in milliseconds; the brakes have to be applied in certain circumstances because the consequences are too great on investors, retirement plans, pension funds, money to create new jobs etc. To most of the investing public, price is a lot more important than speed.
topcoder23 