SEC Blames Computer Algorithm For 'Flash Crash' 218
Lucas123 writes "The US Securities and Exchange Commission and the Commodity Futures Trading Commission today issued an 87-page report (PDF) on the results of a months-long investigation into the May 6 'flash crash' that sent the Dow tumbling almost 1,000 points in a half hour. The Commissions are holding a single trading firm's automated trade execution platform responsible for the crash, saying it dumped 75,000 sell orders into the Chicago Mercantile Exchange over a period of minutes causing an already volatile market to come crashing down. The SEC has already enacted some quick rules to pause trading if a stock price should rise or fall by 10% in a five minute period, but the regulators said they expect the results of the investigation to prompt additional rules limiting the functions of automated computer trading systems."
A time out is the right solution. (Score:5, Informative)
Here's the way this went down. Because this malfunction dumped market (not limited) sell orders without matching buys, they quickly soaked up all of the buy bids that were on the market, leaving only outrageously low buy bids that usually don't see the light of day at the top of the pile. Those got filled too, and suddenly you've got everything trading at 90ish% off what it was a moment before. CNBC and other instant media realizes that something's amiss... Jim Cramer happened to be making his regular afternoon visit to the daytime programming and shouted out a pretend limit buy order for the stock he was scheduled to say was overvalued... he then "sold" that order a few moments later to show there was instant profits to be made by somebody. This selloff was nonsense, and the market quickly recovered to where it was before minus some losses for the fact that some of the investing public was losing faith in the system.
Now, since this was a malfunction, the people who lost 90% instantly and the people in the other side of those trades who made 80% did so by foul play. The flash crash trades were busted (market regulators ordered them undone) and the world went on like this never happened.
There used to be rules that if there was nonsense at the NYSE, the specialist on the floor would ask questions and stop processing trades. If there was no news to make a fundamental change in the stock and there were suddenly sellers but no legit-priced buyers... just shout out that this was going on and some buyers would be sure to show up.
But now, with many electronic places competing with the NYSE, an NYSE-only stop to computers damage that needs to be routed around, and the crash continued at these exchanges. So, the SEC at its level over all of these systems is establishing rules under which every exchange has to stop processing trades in the affected issues until there's enough time for the news of the event has spread and everybody's had a chance to react.
Market rules are based on trying to give everybody involved a fair chance to trade. Trading on information you have that isn't public yet is not allowed. Martha Stewart went to jail because she had money in IMClone, and was called before the news was out by somebody telling her an FDA trial had a failed result. She sold immediately, and then we she realized she had fouled, faked her phone records about the call. Gotta play fair... they are watching.
Re:A time out is the right solution. (Score:5, Informative)
Valuation is an art (Score:5, Informative)
One of the thing that was made clear to me over the last few years was that the price of stock is whatever the last person bid for it.
The price of ANYTHING is the price of the last accepted bid. Always has been, always will be.
It isn't based on the book value of the company.
Not directly, no. Really stock prices are usually based on a collective opinion of the future profit making prospects of the company. Sometimes though they are based on things that have little or even nothing whatsoever to do with profits. (Exhibit A is the dot com bubble in the late 1990s) The stock market is really not much different than any other form of betting and it only secondarily has anything to do with the actual finances of the company.
Value is a subjective thing. I'm an accountant in my day job and I'll be the first to tell you that valuation is probably more of an art than a science. Opinion plays a huge role because the same thing can be worth very different amounts to different people.
The CME Group has issued somewhat of a rebuttal. (Score:3, Informative)
According to the CME Group:
"The 75,000 contracts represented 1.3% of the total E-Mini volume of 5.7 million contracts on May 6 and less than 9% of the volume during the time period in which the orders were executed. The prevailing market sentiment was evident well before these orders were placed, and the orders, as well as the manner in which they were entered, were both legitimate and consistent with market practices. These hedging orders were entered in relatively small quantities and in a manner designed to dynamically adapt to market liquidity by participating in a target percentage of 9% of the volume executed in the market. As a result of the significant volumes traded in the market, the hedge was completed in approximately twenty minutes, with more than half of the participant's volume executed as the market rallied – not as the market declined. Additionally, the aggregate size of this participant's orders was not known to other market participants.
Additionally, the most precipitous period of market decline in the E-Mini S&P 500 futures on May 6 occurred during the 3½ minute period immediately preceding the market bottom that was established at 13:45:28. During that period, the participant hedging its portfolio represented less than 5% of the total volume of sales in the market."
http://cmegroup.mediaroom.com/index.php?s=43&item=3068&pagetemplate=article
The SEC/CFTC report is typical of something that we tend to see come out of government agencies (low quality analysis). Also, they didn't make any meaningful recommendations. It seems like that just tried to rush something out as quickly as possible to say, "Everyting is fine. Retail investors can hazard their capital again. We caught the evil, responsible financial firm and will sort them properly."
Re:Why not just simply ban the practice? (Score:5, Informative)
As a buy-and-hold investor, why do you care whether high-frequency trading exists at all? The flash crash was largely erased shortly thereafter, so it wasn't like it artificially destroyed your wealth. As a person who believes that a core value of our moral system should be those things that do not impinge on the rights of others should be allowed (with notable and obvious exception), I find banning high value trading simply because we are afraid the market will do strange things is silly.
When it comes down to it, the flash crash was a boon for the buy and hold investor, since you got an opportunity to buy things at great prices. And, when it comes times to sell, having a bazillion automated trades in the system ensures your trade will get lost in the liquidity, practically guaranteeing a fair price. Wipe out market liquidity and you are suddenly at the mercy of whoever happens to want to buy that day.
courtesy Peter Schiff (Score:3, Informative)
Numbers below are courtesy Peter Schiff:
October 1 2010
Gold: new high
Silver: new 30 year high
Gold stocks hit 52 week high
Oil: strong day and strong week
Dollar: dropped 13 percent from peak 3 months ago
September is done, media says: this is best September in 71 years. Dow gained 7.7%, SMP gained 8.8%.
However this month of September.
CRB Index (commodities): gained 8.7% - beat DOW and just under SMP
Soy beans: up 9.5% - beat SMP
Copper: up 10% - beat SMP
Rice: up 10% - beat SMP
Oil: up 11% - beat SMP
Corn: up 12% - beat SMP
Silver: up 13% - beat SMP
Frozen concentrated orange juice: up 13% - beat SMP
Cotton: up 17.5% - beat SMP
Sugar: up 19.3% - beat SMP
Currencies:
Swiss Frank: up 4.6%
Euro: up 7%
Australian Dollar: up 9% - beat SMP
--
Realize that this so called 'best September' is no such thing, what you are observing is huge, very fast inflation.
Beware of USD and US bonds.
Fed says that this inflation is still too low, to slow, prices are not rising fast enough for the Fed. Fed wants your prices to go up up up up up up up.
Buy sugar and get out of the dollar.
No bugs, Nothing went wrong (Score:5, Informative)
I just finished reading through the whole report. It's fascinating, if you're into this.
First, none of this involved a "bug" . All systems involved functioned as designed.
What's going on here is a logical consequence of the way the markets are set up. The Chicago Mercantile Exchange ("CME", the futures market, which started by trading grain) has a tradeable commodity called the "E-mini", which is a derivative security based on the S&P 500 stocks. Anyone can buy or sell contracts in E-minis, and can also buy or sell the underlying stocks. This generates a frantic amount of short-term trading from market players trying to profit from the differences between the two, which keeps the price of the E-mini close to the prices of the S&P 500 stocks.
None of this is productive activity, of course.
There's a consolidated feed from all markets that everybody gets. It has a few seconds of lag. To obtain an advantage in fast trading, some of the players buy direct exchange feeds with an average of 8ms (yes, 8 milliseconds) of lag.
What started the crash was that a fundamentals trader (one who actually pays attention to the companies involved) was selling $4 billion in stocks. Ordinarily, this isn't a big deal. They had a program throttling their rate of sale to 9% of market volume in the last minute, to avoid depressing the market. That's normal. So far, so good.
However, in response to this sale, the "high-frequency traders" started frantically trading back and forth to balance their portfolios. Their net effect didn't move prices much, but it pushed volume up. So the big seller started selling faster.
This generated enough volatility that some market players started dropping out, decreasing liquidity. That generated market imbalances which other traders started to exploit. Then, because of all this frantic trading, the consolidated market feed and the millisecond feed differed enough that some trading firms had data quality alarms and dropped out of trading. Since traders who are "market makers" are required to maintain buy and sell bids in the market, they defaulted to their default bids - buy at $0.01, sell at $100,000. Some trades actually took place at those prices. 895 shares of Apple stock were sold at $100,000. The price of Accenture fell from $30 to $0.01 in seven seconds, then recovered within the next minute.
Then "At 2:45:48, trading on E-Mini was paused for five seconds when the CME Stop Logic Functionality was triggered in order to prevent a cascade of further price declines". Yes, a 5-second automatic trading halt. That was enough to start to stabilize the E-mini contract trading on the CME. But by then, the E-mini was enough out of sync with the underlying stocks (mostly on the NYSE) that trading on the NYSE started to move stocks there to resync with the E-mini.
The NYSE still has a trading floor, which slows it down. This didn't help. But that's another story.
Nothing failed. Nobody did anything wrong. The original seller's strategy for unloading $4 billion in stock was reasonable. This is all a consequence of normal market operation. The report concludes that speeding up the consolidated market feed to get the 5-second lag (which was more than fast enough before program trading) down should be done. That's it.
Whether or not society should support an "efficient market" system to this extent is an question one is not supposed to ask.
Let's get few facts straight (Score:5, Informative)
Here are few important facts:
1. Waddell & Reed is the company whose aggressive selling triggered drop in S&P 500 futures price. The company is not HFT shop but rather long-term investment hedge fund. More here: http://www.bloomberg.com/news/2010-09-30/waddell-reed-e-mini-trades-are-said-to-have-helped-trigger-may-6-crash.html [bloomberg.com]
2. According to SEC report, HFT traders played their intended role: smooth out short-term price volatility. However, due to enormous size of Waddell & Reed selloff (about $4 billion dollars in 75000 futures contracts during 20min.) they can do only that much. W&R just cut right through the order book on CME.
3. Slowing down the trading on NYSE did not help but rather hurt by locking up liquidity. Shitty NYSE Arca systems that handle ETFs overloaded and further exacerbated the problems.
4. At the end of day market returned to pre-crash levels. Long term investors were not hurt, W&R payed between 100 and 200 millions for their mistake.
5. Overall, market worked as expected.
Re:No bugs, Nothing went wrong (Score:1, Informative)
Re:Regulatory Agencies Don't... (Score:3, Informative)
As I said, the market is the big guys.
There isn't enough money in the little guys to even make a market, nor so much that if the little guys were removed from direct contact from it they'd make a difference.
Seriously. The little guys don't even know that they're buying nothing when they enter the market. They get a meaningless portion of the votes of a corporation. They might get a meager dividend, but that's one of the carrots used to lure them in; it's certainly no significant piece of the profits. They get no access to the company. They won't be let into the building. They can't see any proprietary information. They don't get a discount. They don't even get the CEO's phone number. Some "owner" that makes them.
The stock market isn't investing. It's gambling. It's an ornate casino run by people who know full well that there are a million suckers born every day, and each one of them has a lifetime of earning power to be squeezed into the funnel.
Re:A time out is the right solution. (Score:5, Informative)
It wasn't the phone company record that the call took place, it was her company record about what was discussed during the calls.
Her phone records that she presented investigators showed she had a pre-existing stop-loss order to sell the stock if it traded below $60, but others testified that was a lie fabricated after the illegal info was given to her. So, there's your obstruction. Yep, they couldn't prove the crime but could prove the cover-up.
Fire up the Wayback Machine, we're headed to March 4, 2004. Fox News [foxnews.com], Forbes [forbes.com], USA Today
Re:Because it works? (Score:1, Informative)
Amen brother, AMEN!
Crash wasn't caused by just one trading house, either....
http://www.zerohedge.com/article/cme-refutes-secs-entire-104-page-wr-scapegoating-drivel-two-simple-paragraphs