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Flash Crash of 2010

On 6 May 2010 the Dow Jones index lost almost 9 per cent of its value in a matter of minutes – in a series of events that rapidly became known as "flash crash." The share values of household names such as Proctor & Gamble and General Electric were washed out by hundreds of billions of dollars. But the carnage, which never before witnessed existed at a pace, did not last long. Surprisingly, by the end of the day, Dow Jones had regained much of its value and closed at 3% lower.

What happened at 2:45 PM, 6 May 2010 that it became such a historic event?

On 6 May 2010, when the US financial markets were opened, the Dow was down and it was in such a position due to triggered fears about Greece's debt crisis.

The stock market started to weaken quickly at 2:42 PM, with the Dow down more than 300 points for the day, falling another 600 points in 5 minutes with a loss of approximately 1,000 points for the day by 2:47 p.m.

It was a crazy event. People were panicking all over, but by the time they could do anything, something weird happened.

The market had reclaimed much of the 600-point decline twenty minutes later, by 3:07 p.m.

At first, while the regulatory agencies and the United States Congress announced investigations into the crash, no specific reason for the six hundred point plunge was identified. People were perplexed, why and how could it happen. Each and every new channel, media house was coming up with new explanations and theories.

Investigators concentrated on a variety of potential factors such as the automated trading or perhaps human traders' errors. The regulators minimised the potential of trader mistakes by the first weekend and concentrated on electronic markets rather than NYSE. However, as a large-scale potential exchange, CME Group reported that its investigation did not show any support for this or that high-frequency trading played a part in terms of stock index futures that were exchanged on CME and in turn concluded that electronic trading led to market stability during the crash period.

But this was not sufficient to console the public, later US SEC and CFTC( Commodity Futures Trading Commission) formed a committee led by Gregg E Burman and they took a 5 month long investigation into the Flash Crash.

This is an excerpt from the SEC-CFTC report on what they had to say about the flash crash -

The combined selling pressure from the sell algorithm, HFTs (High Frequency Traders), and other traders drove the price of the E-Mini S&P 500 down approximately 3% in just four minutes from the beginning of 2:41 p.m. through the end of 2:44 p.m. During this same time cross-market arbitrageurs (Firms simultaneously issuing in one market and buying in other) who did buy the E-Mini S&P 500, simultaneously sold equivalent amounts in the equities markets, driving the price of SPY (an exchange-traded fund which represents the S&P 500 index) also down approximately 3%. Still lacking sufficient demand from fundamental buyers or cross-market arbitrageurs, HFTs began to quickly buy and then resell contracts to each other—generating a “hot-potato” volume effect as the same positions were rapidly passed back and forth. Between 2:45:13 and 2:45:27, HFTs traded over 27,000 contracts, which accounted for about 49 percent of the total trading volume, while buying only about 200 additional contracts net.

Note: Hot Potato Volume Effect is a situation when High Frequency Traders sell and buy stocks almost continuously due to market fluctuations (As they use computer programs) with a very low holding period.

Much of the volume on May 6 was just positions being moved back and forth over a matter of seconds between high-frequency traders and other market makers.

It is also important to note that SEC-CFTC straight up blamed one transaction in starting this chaos.

It noted that "May 6 began to be a very volatile day for the markets," and that "broadly pessimistic investor expectations have influenced the stock volatility rises for certain securities by early afternoon." Around 14:32 p.m. An significant fundamental trader (known as Waddell & Reed Financial Inc.) against a "backdop with exceptionally high uncertainty and thinning liquidity"

A lot of critics of this report have called blaming a single event, naive on the part of SEC-CFTC, but others maintain that this was indeed a key driver.

Now you know the story as well, do you really think that one single event can cause such a significant chaos in the market?

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