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Why We Could Easily Have Another Flash Crash in the stockmarket....THOUSAND POINT DROPS IN SECONDS
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[link to www.dailyfinance.com]
Three years ago, on May 6, 2010, U.S. capital markets experienced the "flash crash," when the Dow Jones Industrial Average suffered a stunning 1,000-point loss (9%) in five minutes, followed by an equally dramatic recovery. It could happen again.
Moments before the 2010 flash crash, individual stocks were trading at a greater than 90% discount to the price. Accenture PLC, for example, was quoted at $39 just prior to the flash crash, then had trades clear at $32.62, then $5.34, $4.04 and $1.84 before recovering to close at $41.09. The point decline in the Dow within a single day was the largest since the Dow debuted in 1896.
Despite the attention received from various news groups, economists, and the Securities and Exchange Commission, which published its findings jointly with the Commodities Futures Trading Commission in a study on Sept. 30, 2010, the specific cause of the flash crash remains in dispute. It's bad enough that the flash crash occurred. Worse though, is that the corrective measures have focused on mitigating the effects of the crash, not the cause.
Market crashes and government attempts to prevent future ones, are nothing new. The 1630s Tulip Mania crash at the end of the Dutch golden age led to government efforts to mediate contracts of affected merchants and hostility toward speculators. The U.S. Panic of 1873 resulted in national governments' embrace of protectionist policies and a shift away from the global silver standard. An investigation into the causes of the Wall Street Crash of 1929 led the Pecora Commission to recommend legislative initiatives which led to the modern securities laws.
Still, the 2010 flash crash exemplifies the risk created by a new and accelerating trend: the market's shift towards and reliance on automated computer systems in trading; and accordingly, a new class of risk to the markets -- the computer-based trading malfunction.
Since this flash crash, other computer-based trading malfunctions, or "glitches," have transpired, highlighting in each case other at-risk areas in the global trading system. On Aug. 1, 2012, Knight Capital suffered a technical glitch in its algorithmic trading systems, causing more than 140 stocks to be misquoted, eventually costing the firm more than $440 million and forcing it to raise significant capital. On April 25, 2013, a computer glitch in the Chicago Board Options Exchange shut down the exchange for half a day, preventing options trading on two of the U.S. stock market's most closely-watched indexes.
Similarly, concerns persist that markets remain vulnerable to the rapid dissemination of disinformation, such as cyber-terrorism initiatives aimed at general disruption. One of these was a false report on April 23, 2013, from a hacked Associated Press Twitter account, that the White House had suffered two explosions and that President Obama had been injured. This report resulted in sharp decreases in the Dow and the Standard & Poor's 500 Index; they rebounded after the AP revealed it had been hacked.
Each incident has prompted careful review and additional changes to regulatory and procedural safeguards by capital markets regulators, including, the SEC, the CFTC and the Financial Industry Regulatory Authority. These changes are largely designed to mitigate the potential risk of volatility or damage caused to the markets.
Regulatory changes generally fall into three categories: circuit breaker modernization, erroneous trade breaking rules, and new rules to strengthen minimum quoting standards. Here's how they each respond to a flash crash:
Circuit breaker modernization. On May 31, 2012, the SEC approved a "limit up-limit down" mechanism that
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