Flash Crash

On May 6, 2010, the Dow Jones Industrial Average plunged from 10,868.12 to an intraday low of 9,869.62. The intraday decline of 998.5 points, or 9.2%, was the largest intraday point drop in history. The index quickly recovered much of the day’s losses and closed down only 347.80 points at 10,520.32. Much of the decline and subsequent rebound occurred within a span of minutes. This was the so-called “Flash Crash” of 2010.

Months later, in October that year, the U.S. Securities and Exchange Commission (SEC) and the Commodity Futures Trading Commission (CFTC) issued a joint report detailing their findings on the causes of the Flash Crash. An unnamed mutual fund, suspected by many to have been Waddell & Reed, sold a large number of E-mini S&P contracts. This eliminated liquidity on the buy-side and placed a large number of contracts in the hands of High Frequency Traders (HFTs). The quantitative, computerized trading systems of HFTs then began aggressively selling down equities and futures contracts, causing the downward spiral in asset prices. As these computerized trading systems detected unusually high trading volumes, many automatically shut down. Liquidity vanished, resulting in abnormal pricing. Accenture, for example, dropped from $40 to $0.01 within a minute. A series of 5 second trading pauses at the Chicago Mercantile Exchange was triggered by all the unusual trading activity. This allowed prices to eventually stabilize and recover.

The SEC has since installed “circuit breakers” to avert a repeat of the Flash Crash. These circuit breakers temporarily halt trading in select, widely owned stocks when their prices become overly volatile. The idea is to bring to the attention of market participants the fast-changing price of the security. In theory, the trading pause gives traders time to reassess the prevailing market price, and it should also help restore liquidity.

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