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  • Writer's pictureDhruv Syam

The 2010 Flash Crash Explained

On May 6th, 2010, the Dow Jones Index lost almost 9% of its value in a matter of minutes. Billions of dollars were knocked off huge companies as markets were left shocked and were quick to label this event the “flash crash” as $1 trillion in market value seemed to disappear. What was even more peculiar was that this historic crash hardly lasted and markets closed just 3% lower than open.

On immediate inspection, there were far and wide theories about how this crash came about. Most theories revolve around either technical glitches on the NYSE or more famously the impact of high-frequency traders.

FIve months after the crash the SEC issued a report and suggested the cause for this crash was a large mutual fund selling a very large number of E-Mini S&P contracts (index fund future contracts). This large sale triggered hundreds of automated high-frequency trading systems (HFTs) to dump these contracts rapidly driving down the price. As they continued to sell, a lack of demand from buyers for this contract led to HFT algorithms buying and selling to each other accounting for 49% percent of the total trading volume. This chaos in the futures market reportedly led to HFT firms pulling back from the equity market leading to low liquidity and the rapid fall in prices.

However, this report was not completely conclusive with many controversies surrounding the SEC’s findings citing that it is quite unlikely that a single order could lead to such a huge tumble. This became more concerning as rumours emerged that there may have been a failure at the NYSE leading to the arbitrary sale of stock.

Nevertheless, the crash was a frightening reminder to markets around the world about the dominance and danger of algorithmic trading which now accounts for over 40% of the trading volume. Regulators were fully awakened to the idea that these interacting machines with no curtails have the ability to completely wreak havoc and have since imposed many protections including trading curbs called stopped circuit breakers that would prevent such a rapid fall in price.

For years analysts have been warning of the dangers of automated trading systems and how they may provide liquidity but severely intensify volatility making the markets too risky. A more volatile market can stoke investor uncertainty and lead to a loss in investor confidence in the long term.

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