2010 FLASH CRASHROSS APTED

WHAT HAPPENED

At approximately 2:45 on 6th May 2010 Prices on the United States stock market fell sharply only to recover minutes later.

The Dow Jones dropped 600 points during the crash adding to 300 point drop that day(due to Greek debt crisis).

Most of the 600 point drop was recovered within tens of minutes.

Dow Jones – Important Index of the stock of 30 large companies that are representative of the United states economy. Represents state of market.

(The staffs of the U.S. Commodity Futures Trading Commission and the U.S. Securities and Exchange Commission. )

Charging Bull statue near Wall Street in New York symbolizes a Bull market - where prices in the market are on a upward trend.

THE STOCK MARKET

Stock Market - The market for the trading and issuing shares (company stocks) done

via stock exchanges.

Stock Exchange - Provides a services that allow securities (stocks, bonds etc.) and financial instruments to be traded.

Ensures fair and orderly trading.

Effectively disseminate data on the prices of securities.

Stock exchange simulator:

http://www.howthemarketworks.com/

STOCK EXCHANGE

Major financial institutions situated around world around world. UK has London Stock Exchange.

core roles:

1) Raise capitol for new firms by shelling a share (stocks) in the company. Primary Market

2)Prove a platform for people to sell and buy shares (stocks).Secondary Market

Stock – A unit of ownership in a corporation entitling you to part of the assents and profits of the corporation.

BusinessStock

Exchange

Member of public

Business raises money by selling

shares in the company

Business pays shareholders

dividend

Sells shares on the second hand market

Buys shares on the second hand market

Key Cash flow

Dividend – Payment of a proportion of the companies earning to the share holders. Proportion Decided by the board of directors. (Cash amount per share)

FINANCIAL INSTRUMENTSA document representing a legal binding agreement involving Monterey value.

S&P 500 – A market weighted Index based on the stock prices of 500 American companies.

Representative of industries in the U.S. economy thus a good indicator of the U.S.

economic market.

S&P 500 contracts – Are future contracts that are traded as a bet on where the S&P 500 index

will be in the future. The value of one of these contracts is $250 multiplied by the value of the S&P 500 index.

E-MINI S&PAND EXAMPLE

E-MINI S&P – A smaller more affordable version of the S&P 500 contract. The value of one of these

contracts is $50 multiplied by the value of the S&P 500 index.

Example

Say that E-MINI S&P is trading at 1000(S&P 500 index at 100 points). Then the trader controls $50,000 of the S&P 500 index stocks. As the index increases or decrease the contract can be sold for more or less money.

HIGH-FREQUENCY TRADING

Powerful computerized trading tool that executes a large number of trades at high speeds.

Algorithms used to used to monitor multiple market factors orders are executed based on market state.

Make pennies on each trade that accumulate. The faster the trader the more profit is made.

Provide liquidity to the market.

Liquidity – The amount a security can be traded without a change in there price. A liquid security is one

that can be bought and sold with ease.

New York stock exchange 1979 - Santi Visalli

INVESTIGATING THE CRASH

THE CRASH

Caused prices of most of the 8000 securities on the market decline rapidly

Prices fell up to 15% in some cases.

20,000 trades took place at the time of the crash were price 60% away from the pre-crash values.

Some trades occurred as high as $100,000 or as low as less than a penny.

Prices retuned to pre-crash levels moments later.

DOW JONES INDEX ON THE DAY OF THE CRASH

CFTC AND SEC REPORTOfficial report on the crash by the U.S. government.

Event 1: Unsettled market

Safe premiums(safe assents e.g. gold) prices increased to protected against the Greek debt crisis.

Euro declined rapidly the Dollar and Yen.

Market volatility increased and Liquidity Replenishment Points triggered.

Liquidity Replenishment Points - triggered by individual stocks. Takes triggering

stocks of the market for a time to decrease the

volatility.

(The staffs of the U.S. Commodity Futures Trading Commission and the U.S. Securities and Exchange Commission. )

liquidity of the E-mini future contracts had by 55% that morning.

Volatile and illiquid market.

Event 2: Sell Algorithm

A large trader executed a sell Program to sell 75,000 E-mini contracts. Done to hedge an existing position.

Sell algorithms normally take into account price, time and trading volume. This algorithm was set to only car about trading volume.

Sell rate set at “9% of the trading volume calculated over the previous minute”

Stock was sold 15 time faster than a previous trade of that size.

Flood of E-mini deceasing liquidity

Event 3: High-frequency trading

Initial contrast were absorbed by fundamental buys in the future market. They then left the market.

High-frequency traders began to buy large amount E-mini contacts.

Price of E-mini contracts dropped by 3%

The High-frequency traders due to their nature did not hold on to there position stated selling to each other. Report states that a “hot potato” situation was created sold back and forth to each other. Sell volume increased algorithm speed

High-frequency traders dropped out of market.

Liquidity further decreased and price of E-mini dropped 6%

No liquidity in E-mini market.

Stop-logic on Chicago Mercantile Exchange trigged in order to prevent a future price declined.

E-mini market paused. Sell side pressure was alleviated. Market recovered

Flash crash was over.

Outcome

Circuit breakers were installed on the New York Stock Exchange S&P stock that are trigged when the stocks rise of fall by 10% in a 5 minute period.

ACADEMIC LITERATURE

THE MICROSTRUCTURE OF THE ‘FLASH CRASH’ (Easley, Lopez de Prado, & O'Hara, 2010)

Provides supporting evidence that illiquidity caused the crash as detailed in the CFTC report.

Key points:

Order flow toxicity an its role in the crash.

Order flow toxicity – likelihood that “informed traders” (hedge funds, large human controlled traders) incorrectly select “uniformed traders”(HFT). (Easley, Lopez de Prado, & O'Hara, Flow Toxicity and Liquidity in a High Frequency World, 2012)

Illiquidity is unknowingly created.

Use the VPIN flow Toxicity metric which provides measure of the liquidly that is being provided.

When flow to toxic market maker forced out of market, feed back increase effect and liquidity is lost.

(Easley, Lopez de Prado, & O'Hara, 2010)

Solution:

“The creation of an exchange-traded ‘VPIN contract”

Give market makers a means of measuring flow toxicity

A way for HFT to hedge against being adversely selected, they could stay in the market an keep providing liquidity.

CME Report

The 75,000 E-mini trade was not the cause, it was within regulation.

High-frequency traders were not the cause, they help market recover.

That no errors or misconduct was found.

(CME Group, 2010)

REFERENCES

CME Group. (2010). What Happened on May 6th? Chicago: CME Group.

Easley, D., Lopez de Prado, M. M., & O'Hara, M. (2012). Flow Toxicity and Liquidity in a High Frequency World. Review of Financial Studies , 1457-1493.

Easley, D., Lopez de Prado, M. M., & O'Hara, M. (2010). The Microstructure of the ‘Flash Crash’: Flow Toxicity, Liquidity Crashes and the Probability of Informed Trading. he Journal of Portfolio Management , 118-128.

The staffs of the U.S. Commodity Futures Trading Commission and the U.S. Securities and Exchange Commission. . FINDINGS REGARDING THE MARKET EVENTS OF MAY 6, 2010 . Washington, D.C : U.S. Commodity Futures Trading Commission and the U.S. Securities and Exchange Commission.