Both the SEC and congress have now undertaken a review of the events of 2:45 PM May 6, 2010.
I can’t prejudge their decisions, but I am sure that they must take drastic action or this event will certainly happen again.
Why will it happen again? About 70% of trading on and off the NYSE is program trading done by computers using algorithmic codes. Wall Street has lobbied congress and the SEC to allow this so called flash trading and “Dark Pools”. I first wrote about this phenomenon in August of 2009 and suggested it gives Wall Street firms an unfair advantage over other investors. No wonder Goldman Sachs can brag that they made money trading every day last quarter. They know the cards in the deck and what everyone else is holding before they trade. In any casino, this would be known as an unfair advantage. The exchanges are supposed to be better than a casino.
This advantage was sold to Regulators on the basis that it provided liquidity to the market. However, it also sucks liquidity out of the system as last Thursday’s crash illustrates.
All the program trading and computers use the same logic.
Therefore, when they want to sell, they all want to sell, when they want to buy they all want to buy. This adds volatility to the markets hence the wide swings we see more often. It also means, in times of stress that the chances of an event such as we witnessed increases.
In the current instance, when a single trader entered a large order for $12 Billion, the computers saw this and instantly sold, starting a run. The NYSE shifted into “slow mode” the effect of which was to shift the orders to humans (specialists charged with maintaining an orderly market, and other exchanges. (There are more than a dozen other exchanges). Both the specialists and the other exchanges were swamped.
Specialist can leave a “stub price” at which they will execute and trade and many left one penny. The computers thought “heck of a deal” and bought, so many orders by short sellers, and stop loss orders as well as market orders were executed. They were later canceled by the exchange.
The solution is, there must be a uniform rule across all exchanges providing for a “circuit breaker” where the markets stop trading for a period, perhaps only one minute, to gather its’ senses.
Will the SEC provide such a solution?
In the meantime, don’t panic when these events occur.