The May 6 Flash Crash

Dear Reader,

This week I discovered an attention-grabbing article while browsing through the news on Sunday. Why attention-grabbing?, because the headline published on the FT webpage, “Flash Crash was sparkled by single order”, directly caught my eye. I like to read articles with headlines falling out of the line. When I read crash I automatically associate it with the Financial Crisis, but this one is about the United States stock market.

(Dow Jones Traders at the 6th of May)

The story is about a mysterious happening on the stock market on the 6^th of May, where the Dow Jones had the biggest one-day point decline of 998.5 points in the history of this index, as you can also see on the chart below. 

(Source: http://kelloggfinance.files.wordpress.com/2010/05/chart_dow_dip2-top1.gif?w=475&h=246)

300 points of the drop were related to the debt crisis in Greece, but the other almost 700 points were inexplicable for everyone in the financial world. The index lost over 600 points in five minutes at 2.47 pm. on that day and regained most of the drop at 3.07 pm, which means ten minutes after.


I found an interesting video about the mystery of the huge drop, which is worth looking at. 
http://www.youtube.com/watch?v=Ne4cD9UYoo4&feature=related

After five rejected and disproved theories for a possible explanation and five long months, the Securities and Exchange Commission (SEC) and Commodity Futures Trading Commission (CFTC), published a joint report on the 1^st of October, with the solution for the cause that set of a sequence of events leading to the unusual happening on the 6^th of May. The report found that the cause was a single sale of $4.1 billion in 75.000 E-Mini contracts (electronic stock market future contract) in twenty minutes, by a mutual fund, identified as Waddell & Reed Financial, in an aggressive attempt to hedge its investment position. Due to the debt crisis in Europe the market have been very nervous already, therefore the transaction has triggered a huge sell-off, according to the Final Report.

In my opinion, the vulnerability of the equity market, dominated by the e-traders is the main cause for this type of domino effect. The regulators were not able to explain this type of irregularity for five months, also showing how complex the stock market system is, even for the Commissions supervising these markets.

This so-called ‘Flash Crash’ should fuel a debate on whether a greater regulation on such high speed trading is needed to protect the market from such incidents.

Quoting the SEC and CFTC Chairman’s joint statement “We now must consider what other investor-focused measures are needed to ensure that our markets are fair, efficient and resilient, now and for years to come”, I think that this is a rather nicely formulated proclamation. At the end of the day one of the biggest US stock market indices was hit massively by only one mutual fund, which in my opinion is something to be worried about.

E.V.

Sources:


1. Die Presse


http://diepresse.com/home/wirtschaft/economist/599271/Raetsel-um-USBoersencrash-im-Mai-ist-geloest?_vl_backlink=/home/wirtschaft/economist/index.do



2. FT

http://www.ft.com/cms/s/0/8ee1a816-cd81-11df-9c82-00144feab49a.html

3. FAZ


http://www.faz.net/s/RubF3F7C1F630AE4F8D8326AC2A80BDBBDE/Doc~E68F762A5B7E8470592912B290CE6426A~ATpl~Ecommon~Sspezial.html