SEC Issues "Flash Crash" Report

The Securities and Exchange Commission and the Commodity Futures Trading Commission in the US have released a report dated September 30, 2010 (Report) identifying the root causes of the “flash crash” that overtook North American stock markets on May 6, 2010. On that day, a computerized trading program executed an algorithm to sell over $4 billion in futures (specifically, E-Mini Futures) over a period of only 20 minutes. The rapid liquidation of this market had a dramatic effect on other indices, such as the Standard and Poor’s Index, effectively causing a brief panic on the markets. Some blue chip stocks that had been trading for $60 dropped to pennies a share before recovering. Although the stock market has some built-in protection that stops trading when prices drop too far too fast, in this instance the “circuit breaker” stop of five seconds was not long enough to prevent the effect of a rapid decline of one market from propagating to others. It seems to be widely accepted that this effect should not be permitted to occur, being an artificial state of liquidity that does not reflect true market demand. Although the events that lead to the “flash crash” are now better understood, there is continued debate on how to prevent a recurrence. The Report identifies one key factor. A much longer pause in trading activity of five minutes, instead of five seconds, should allow purchasers the opportunity to catch-up with a rapid sale to stabilize prices. However, some wonder whether this is sufficient, given the extent and sophistication of computer trading algorithms, and the interconnectedness of worldwide markets. For a copy of the Report, see: http://www.sec.gov/news/studies/2010/marketevents-report.pdf For news reports, visit: http://tinyurl.com/3x4kb7c; and http://tinyurl.com/3alt27h Summary by: James Kosa