What caused the flash crash?
Dow Jones loses almost 1 000 points – and recovers instantly. How?
YOU CAN’T BLAME the conspiracy theorists for their outrageous ideas as to how markets in the United States managed to shed almost 1 000 points on 6 May. It was weird. Almost a trillion dollars worth of equity were wiped out in a flash – and then recovered almost as quickly.
The strangest theory as to how that happened I’ve heard so far involves the testing of a flash-trading computer system by Goldman Sachs designed to make extremely short-term trades. According to the story, the system was turned on and subsequently caused the trouble before being shut down. Yeah, right. Another theory postulates a typo caused the crash, with a trader specifying billions instead of millions. Not likely.
The more sane theorists seem to think it was simply the reaction of a skittish trading community shaken by the drastic downturns of 2008 and committed to selling fast when things looked like returning to that situation. That seems more plausible – except that flash trading is supposed to be limited by systems installed in the Eighties. The New York Stock Exchange installed circuit breakers after the 1987 crash designed to prevent that sort of thing.
The question now foremost in investigators’ minds apparently concerns market access, since loopholes in the trading ingress are thought to be a contributor. The US Securities and Exchange Commission (SEC) has started its investigation under the guidance of its chair, Mary Schapiro. Flies on the wall report no conclusions have been made yet and that the investigation will take time.
That’s often referred to as “naked” access and allows regulated broker/dealers to lease out their access to the exchanges to unregulated clients.
Last Monday posted a report on its website saying it had traced a “Black Swan” hedge fund trade by Universa Investments that appeared to have sparked the flash trading. “On any other day, this $7,5m trade for 50 000 option contracts might have briefly hurt stock prices, though not caused much of a ripple. But coming on a day when all varieties of financial markets were deeply unsettled, the trade may have played a key role in the stock-market collapse just 20 minutes later.
“The trade by Universa – a hedge fund advised by Nassim Taleb, author of – led traders on the other side of the transaction, including Barclays Capital, the brokerage arm of British bank Barclays plc – to do its own selling to offset some of the risk, according to traders in Chicago.”
With SEC investigations under way, the truth behind the brief crash should emerge over time.
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