Best of the Week
Most Popular
1.Election Forecast 2015 - Opinion Polls Trending Towards Conservative Outright Win - Nadeem_Walayat
2.UK Solar Eclipse - End Time Sign, Judgement Day, Doomsday! - Nadeem_Walayat
3.Gold And Silver - When Will Precious Metals Rally? Not In 2015 - Michael_Noonan
4.Preparing for the Next Stocks Bear Market - Forecast 2015-2016 - Gary_Savage
5.Is a Stock Market Crash Imminent? - David Eifrig
6.Gold Price Slumps as US Dollar Soars, What's Next? - Nadeem_Walayat
7.US Dollar Forex Pairs and Gold Chartology - Rambus_Chartology
8.Election Forecast 2015: The Day Labour Lost the General Election - Nadeem_Walayat
9.The ECB Should End QE Next Month - EconMatters
10.Silver Price Poised to Surge - Zeal_LLC
Last 5 days
Don’t Celebrate the U.S. Housing Market Recovery Yet - 30th Mar 15
A Middle East Nuclear Holocaust - 30th Mar 15
Peak Gold? – Goldman Sachs Research Warns of Peak Gold Production - 30th Mar 15
With Yemen Burning, Arab Spring II Is Underway - 30th Mar 15
No FED Bets From the BIS - 30th Mar 15
Election Forecast 2015 - Debates Boost Labour Into Opinion Polls Seats Lead - 30th Mar 15
Economic Recovery, Geopolitics and Detergents - 30th Mar 15
U.S. Dollar, Commodities and the Gold Miners GDXJ ETF Analysis - 30th Mar 15
Stock Market Short-term Downtrend - 30th Mar 15
David Cameron Election 2015 Debate Facts Check - Employment, Immigration, Debt & Deficit - 29th Mar 15
Stock Market About Ready to Crash! - 29th Mar 15
Reflections in a Golden Eye - Gold Market Rejection, Repatriation and Redemption - 28th Mar 15
Stock Market Inflection Point - 28th Mar 15
Gold And Silver - What Moved Price? Bab el-Mandeb And Uranus Square Pluto. What?! - 28th Mar 15
Stock Market Investment Parachutes; Do You Have Yours? - 28th Mar 15
Peak Gold Misunderstanding, is Gold About to Run Out? - 28th Mar 15
Deflation Watch: Key U.S. Economic Measures Turn South - 27th Mar 15
The Hard-Earned Truth About Recreational Real Estate - 27th Mar 15
Bitcoin Price Still in Important Territory - 27th Mar 15
Stocks Bear Market Conditions - Index Market Range Warning - 27th Mar 15
BEA Leaves Q4 2014 U.S. GDP Growth Essentially Unchanged at 2.22% - 27th Mar 15
Brazil Economy Victim of Vulgar Keynesianism - 27th Mar 15
Gold to Fuel Silver Price Upleg - 27th Mar 15
Gold and Silver Stocks Will Rise Again! - 27th Mar 15
Risk of ‘World War’ between NATO and Russia on Ukraine as Yemen Bombed - 27th Mar 15
FOMC Minutes Turned The Gold Tide - 27th Mar 15
Sheffield Hallam Election Battle 2015 - Lib Dems Go to War Whilst Labour Sleeps - 27th Mar 15
Gold Effect On Mining & Shale Wasteland - 27th Mar 15
How Stock Investors Should Play the 2016 Presidential Race - 26th Mar 15
MidEast Energy Alert: Why the Crisis in Yemen Could Get Ugly Very Fast - 26th Mar 15
Stock Market Downward Spiral of Dumbness - 26th Mar 15
The Monetary Approach Reigns Supreme - 26th Mar 15
Stock Market Large Gap Down, Despite the Algos' Push Back - 26th Mar 15
Crude Oil Surges, Gold price Spikes as Middle East Tensions Escalate - 26th Mar 15
The U.S. Housing Market Recovery Is Fabricated Optimism - 26th Mar 15
Why Yemen Is The Next Saudi-Iranian Battleground - 26th Mar 15
The Crude Oil Price Crash and China Economic Slow Down - 26th Mar 15
Global Financial Markets Are More Distorted Than Ever Before - 26th Mar 15
One More Stock Market Rally and Then a Huge Drop Expected - 26th Mar 15
Danger Will Robinson - Stock Market Crash Warning - 25th Mar 15
Learn the Basics of Corrective Elliott Waves - 25th Mar 15
Why CNBC Is Hazardous to Your Financial Health! - 25th Mar 15
Will Your Retirement Accounts Survive The Coming Tax Code "Revolution"? - 25th Mar 15
US Dollar - Americas Phoenix - 25th Mar 15
California’s Epic Drought: Only One Year of Water Left! - 25th Mar 15
What’s Wrong With Silver? - 25th Mar 15
SPX Futures Appear Weak. WTIC and Gold May Be at Max Retracement - 25th Mar 15
We’re at the Dawn of a “New Energy Age” - 25th Mar 15
A Very Weak U.S. Economic Recovery - 25th Mar 15
Zero UK CPI Inflation Rate Prompts Deflation Danger Propaganda For Fresh Money Printing - 25th Mar 15

Free Instant Analysis

Free Instant Technical Analysis


Market Oracle FREE Newsletter

US Economy Still on Life Support

Flash Crash of 2010: Could the Dow Tumble 1000 Points Again?

Stock-Markets / Financial Crash May 09, 2013 - 12:41 PM GMT

By: Money_Morning

Stock-Markets

We've just marked the third anniversary of the Flash Crash of 2010.

That May afternoon was already a down day for the Dow, with the index off by about 300 points since trading opened. Then, at 2:45 p.m., the Dow rapidly plunged by another 600 in just five minutes. By 2:47 p.m., the Dow had lost a staggering 998.5 points.

By 3:07 p.m., the losses had reversed and the Dow picked up most of those 600 lost points. In just about 20 minutes, the Dow had lost close to 9% of its total value - and then regained it.


But those 20 minutes were a virtual eternity, during which nearly $1 trillion in market value essentially disappeared.

Trades could be had for truly cartoonish prices. For instance, shares of The Procter & Gamble Company (NYSE: PG) - the bluest of the blue chips - famously dropped 37% in all, while Jim Cramer provided running color commentary as the stock plunged from $61 to $47, screaming, "It's Procter & Gamble... Just go buy it! That's not a real price!"

Reporters out on the floor began waylaying anyone at a trading desk, getting fractured, distracted sound bites.

Viewers could hear frenzied, bloodcurdling man-shrieks of "Buy! Buy!" over their coverage, as the talking heads began muttering darkly about "the capitulation." Such wonders were very common during those 20 furious minutes, as the New York Stock Exchange began to resemble nothing so much as the Fall of Saigon - without all the helicopters.

After 3:07 p.m., when the losses had begun to reverse, officials and technical experts on the trading floor and at the Securities and Exchange Commission were at a loss to explain the phenomenon. Something really weird had happened. Was it a virus? A malicious attack? A plain old glitch? There were calls for an investigation, to put it mildly.

It was none of these things. Systems, or their various components, actually worked more or less as intended. And that was the whole point. The system, a key component of it, functioned normally... and wiped out $1 trillion.

High-Frequency Trading, Slowed to a Human Pace

This video captures the light-speed process of high-frequency trading, and slows it down for the human eye to see - and the human mind to comprehend. The activity and the concepts behind it are nothing short of stunning.

The action in the video you're about to watch takes place in just half a second of real time. That's just slightly longer than it takes a person to blink an eye, or for that person to fall about four feet.

Take a look at HFT in action: Nanex - Order Routing Animation - May 2, 2013, Johnson & Johnson (NYSE:JNJ)

We can easily see the blistering speed. The time stamp at the 6 o'clock position captures milliseconds - that is thousandths of a second - of time, and we can see it advance. Just above the time stamp, we can see the National Best Bid/Offer and the virtual "ticker tape" of the Consolidated Quote System. At this hyper-slow speed, we can watch as the price changes dramatically from one millisecond to the next. In this context, it's easy to understand why so much money is being invested in infrastructure, such microwave towers and trans-Atlantic cables, to make communications run milliseconds faster.

Each of the 12 boxes represents an exchange, with orders flowing through the interconnected systems. If any of the connections aren't working perfectly, small discrepancies begin to crop up. This represents opportunities for high-frequency traders to arbitrage the many miniscule price differences - and bank huge profits, one fraction of a cent at a time.

Living On a Thin Line

Enter the high-frequency traders.

These semi-anonymous mega traders employ powerful computers and sophisticated algorithms to capture profits a few fractions of a cent (or other currency) at a time. They bombard the markets with scores of millions of quotes - most never meant to be executed. The effect of the sheer volume and nature of these orders is, in essence, manipulative.

One-hundredth, even one-thousandth of a cent per trade. That's a hard dollar, for sure. But a high-frequency trader might take up and exit tens of thousands of positions - maybe even more - in a single trading day, grinding out fractions of a penny at a time.

A few tens of millions of trades like that, and pretty soon you're talking serious money. Portfolio manager Irene Aldridge says, in an understatement, that those fractions of a cent can add up to "significantly positive results at the end of every day."

Money Morning's own Shah Gilani has another, somewhat less charitable way of putting it, calling high-frequency trading "an abomination."

The SEC and the NYSE have embraced high-frequency traders, offering those who can afford it leased space next to the exchange. They insist that high-frequency traders act as market makers, setting prices and providing liquidity. In reality, they are tolerating - even encouraging - manipulation and access-peddling to those who can afford the huge outlay needed to run and maintain a high-frequency trading system. Shah Gilani wrote that chains of fixed microwave towers are going up all over New York and Chicago to enable speedier communication between the two financial command centers, in part to enhance high-frequency trading systems.

Bloomberg has found that sometime in the spring or summer, Hibernia Atlantic will start laying cable for Project Express - a new trans-Atlantic cable which will shave milliseconds off the current 60 milliseconds it takes for information to travel between the East Coast of the United States and Western Europe. Project Express is being built expressly for traders at a cost of $300 million. High-frequency traders will surely make very good - and profitable - use of those milliseconds.

High-frequency trading seems to be here to stay, despite opposition from those who say that eliminating it would lead to trading at a more human, and thereby stable, pace. In the meantime, they'll keep on keeping on, eking out a few hundredths of a cent, millisecond after millisecond, day after day, faster and faster, leaving mere human traders choking on the dust.

High-Frequency Trading: Technology Run Amok

But how did high-frequency trading contribute to the Flash Crash of 2010?

The SEC and the Commodity Futures Trading Commission issued a report titled "Findings Regarding the Market Events of May 6, 2010." That report asserted that high-frequency trading played a big role in the Flash Crash. Its role would be, simultaneously but in different places, perpetrator, enabler, bystander and even victim.

The report found that the market was already shaky on May 6, 2010. Amid this, a Waddell & Reed Financial mutual fund sold a block of 75,000 E-Mini S&P 500 futures contracts worth $4.1 billion as a hedge.

That 800-pound gorilla of a hedge was executed by a computer program - a flawed computer program. Waddell & Reed had executed similarly sized trades before, using a combination of manual order entry and computers. The trades took about five hours to execute at that time, but on May 6, 2010, the algorithm executed the trade in just 20 minutes.

High-frequency traders, sensing some opportunity, hopped on the bandwagon as the E-mini came under intense pressure in a relatively short amount of time. At that point, the decline spilled over into equities.

The report went on to say that the computer program behind this one sale basically blew away most of the buyers on the market. Market liquidity dried up, and some high-frequency traders exited the market because "the automated systems used by most firms to keep pace with the market paused." They paused because the computer systems detected a big spike in buying and selling. Still other high-frequency traders stayed in, andpunched the selling up to Warp 7.

The cumulative result was the Flash Crash, with high-frequency traders on both sides of the problem. The Flash Crash ended as the Dow recovered most of its losses, with most stocks on the index closing down about 3%.

Just a Little Bit of History Repeating

The Flash Crash was just one extreme example of high-frequency trading run amok.

We recently saw a mini-Flash Crash when a hoaxer compromised an Associated Press Twitter account. The tweet, "Breaking: Two Explosions in the White House and Barack Obama is injured," was quickly spotted as a fake. But the lightning spread of this fake news, coupled with the natural "Sell!" reactions of every trader - including high-frequency traders - led to a steep, rapid selloff in the markets.

As before, sanity reasserted its fragile grip, and the markets recovered, but the potentially horrible synergy between viral hoaxes and high-frequency trading and a twitchy market was laid bare.

Stocks come under attack by high-frequency traders every day, targeting a stop-loss here, a sell order there. When high-frequency traders target index funds ahead of a mutual fund rebalancing its portfolio, they can anticipate the changes in price and "eat into" the fund's performance, diminishing your return. Since high-frequency trading is essentially manipulative, that shouldn't come as a surprise. We just don't hear about it when it happens to a stock here, or an ETF there, over the course of a "normal" trading day.

As long as toothless regulators embrace high-frequency trading, claiming it has a vital market-making and liquidity-providing function, the markets will still be at at risk, forever unfair. Even more disconcerting is the thought of just who stands to lose the most when high-frequency trading runs the day right off the rails.

That's your portfolio out there. Can it stand up to 1,000-point swings that might not bounce back in 20 minutes? Is it strong enough to withstand an onslaught of unfeeling machines helmed by craven one-hundredth-of-a-penny grabbers? When will the next Flash Crash happen, and just how bad will it be?

Unfortunately, due in part to high-frequency trading, it's not a question of if, but when.

Do you remember the market chaos that ensued three years ago? Did you get burned by Flash Crash 2010? You're invited to reminisce about the #flashcrash or find out more about #highfrequencytrading on Twitter with us ;@MoneyMorning. Just don't try to pull any hoax assassination tweets! If you've got memories of the Flash Crash to share, visit us on Facebook and drop us a line on our wall.

Source :http://moneymorning.com/2013/05/08/a-look-back-at-the-flash-crash-of-2010-when-will-it-happen-again/

Money Morning/The Money Map Report

©2013 Monument Street Publishing. All Rights Reserved. Protected by copyright laws of the United States and international treaties. Any reproduction, copying, or redistribution (electronic or otherwise, including on the world wide web), of content from this website, in whole or in part, is strictly prohibited without the express written permission of Monument Street Publishing. 105 West Monument Street, Baltimore MD 21201, Email: customerservice@moneymorning.com

Disclaimer: Nothing published by Money Morning should be considered personalized investment advice. Although our employees may answer your general customer service questions, they are not licensed under securities laws to address your particular investment situation. No communication by our employees to you should be deemed as personalized investent advice. We expressly forbid our writers from having a financial interest in any security recommended to our readers. All of our employees and agents must wait 24 hours after on-line publication, or after the mailing of printed-only publication prior to following an initial recommendation. Any investments recommended by Money Morning should be made only after consulting with your investment advisor and only after reviewing the prospectus or financial statements of the company.

Money Morning Archive

© 2005-2015 http://www.MarketOracle.co.uk - The Market Oracle is a FREE Daily Financial Markets Analysis & Forecasting online publication.


Post Comment

Only logged in users are allowed to post comments. Register/ Log in

Free Report - Financial Markets 2014