If you follow the stock market at all, you will no doubt have been aware of the events that occurred on the afternoon of May 6th, in what has now come to be known as the “Flash Crash”. This was the 1000-point drop and subsequent rally in the Dow Jones Industrial Average, all of which happened over a period of just 20 minutes. It was completely unprecedented; the market had never fallen so far so quickly before.
However, what exactly caused the crash is still something of a mystery. Nobody now believes the initial theory doing the rounds, that it was some fat-fingered trader entering a sell order of a billion shares instead of a million. There are too many pre-trade risk controls in place to allow something like that to happen these days. Besides, there was absolutely no evidence to support that theory.
Another theory is that it was a deliberate act by a hacker or a cyber-terrorist who had access to one of the exchange’s matching engines, but again this theory doesn’t stand up to any kind of scrutiny.
The latest view on the flash crash, and the one that seems to be most likely according to the High Frequency Trading Review, is that a hedge fund sent a wave of sell orders came in to the CME’s e-mini S&P futures contract, which drove the price downwards. Because the markets were already nervous on the back of events unfolding in Greece on the back of the debt crisis there, the downward movement picked up momentum, stop loss orders were triggered creating a downward spiral and panic set in. As soon as traders realized there was no fundamental reason prices should have fallen so low, the market immediately rallied.
This kind of thing has happened before, but now that all of the markets operate on electronic trading systems, momentum can gather much more quickly now than it ever has in the past.
If this explanation is true, then hold on to your hat because this is probably not the last time you will see a “Flash Crash”. Expect more of the same as market technology gets faster.
