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The Almighty Buck Businesses United States

SEC Blames Computer Algorithm For 'Flash Crash' 218

Posted by Soulskill
from the steve-jobs-agrees dept.
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."
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SEC Blames Computer Algorithm For 'Flash Crash'

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  • by LostCluster (625375) * on Friday October 01, 2010 @04:48PM (#33765524)

    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: (Score:3, Interesting)

      by Maxo-Texas (864189)

      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.

      It isn't based on the book value of the company.

      If 99.9999% of the stockholders are not selling or buying- then the .00001% of remaining traders can walk the price wherever they want to walk it.

      • by LostCluster (625375) * on Friday October 01, 2010 @05:03PM (#33765684)
        Not quite. A stock's quote price is the last price at which a bidder's offer matched a seller's asking price. A "level 2" quote has two parts, the highest bid price that hasn't been matched up yet, and the lowest asking price that hasn't matched up yet. The true value is somewhere in between these two, but nobody knows where until somebody steps in between the high bid or low offer or somebody moves their price to get a deal. Any computer programmer should check that there's matching orders on the other side of their trade before placing a large order. A program that doesn't will execute just fine, but crash the economic system.
        • by Obfuscant (592200)
          Any computer programmer should check that there's matching orders on the other side of their trade before placing a large order.

          Umm, sounds like a chicken/egg problem. I can't put in a buy order unless there is a sell to cover it, and I can't put in a sell unless there is a matching buy?

          Who's on first?

          • by LostCluster (625375) * on Friday October 01, 2010 @05:20PM (#33765864)

            Put in a market buy order with no limit, and you open yourself to limitless losses if there's nobody willing to sell at the moment. You'll match the first offer to sell no matter how high it is.

            Put in a market sell order with no limit, and if there's no covering buy order you just put in a request to give it away for a penny a share.

            Limit orders rule.

            • What I don't understand is why aren't all orders limit orders?!

              • Re: (Score:3, Interesting)

                by christoofar (451967)

                You use a market order if you have no time to sit and wait for your limit to trigger and you're very motivated to buy or sell to get rid of a stock or to pick a stock up off the floor.

                Market orders rule when it's 3:59:50 and you WANT to get that trade done so you don't get exposed to overnight trading and the morning futures market.

        • by Maxo-Texas (864189) on Friday October 01, 2010 @05:27PM (#33765926)

          But if a large organization wanted to sell stock to itself at increasingly higher or lower prices there isn't anything you can do to stop it. It's illegal as hell but hard to prove.

          the only thing that makes prices rational is a fluid market.
          A low volume market produces irrational prices and makes it easy to move prices around inside the limits of rational prices.

          Put it this way...

          Millions of baby boomers are locked in on a large chunk of their retirement money at 14,000 dow.

          As they get older that price they are willing to accept to cash out is degrading (a lot of boomers would cash out immediately if the market got above 13,000 now).

          As long as the price doesn't get too high or too low, the boomers are paralyzed and the market is not fluid.

          In 2012 to 2016, that price will degrade more. I think we have a decade of overhead pressure from boomers cashing out. At some point, the price won't matter- they'll *have* to cash out to pay bills or go back to work (oh yea, you can't really find work if you are in your 60's these days- I mean 50's.)

      • Valuation is an art (Score:5, Informative)

        by sjbe (173966) on Friday October 01, 2010 @05:30PM (#33765952)

        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 last accepted bid is the historical price even if it was just a few seconds ago. Where it's going next is up for debate.

        • Re: (Score:3, Interesting)

          by nelsonal (549144)
          The dot com bubble more or less correctly predicted the eventual value of ebay, amazon, and google. The problems were

          a) no one had any idea who the winners would be

          b) the game was sort of a tournment for firms so there were going to be many losers and only a few winners, and

          c) most of the dot com companies issued very small portions of the company.
    • by TheSunborn (68004)

      What malfunction?

      Yes it was a single sell order which started it all, but what was the malfunction? The sell order did what the developers wanted it to do so there were no malfunction. There may have been an non-optimal sell order but that is all.

      • by geekoid (135745)

        It sold the stocks too fast.

        When moving that many stocks, you do it in bits. Otherwise people loose confidence.

        • Re: (Score:3, Insightful)

          by LostCluster (625375) *

          Safety rules are there to prevent people from being stupid even if they want to be stupid.

      • The problem was in bad design... nobody bothered to check that there were enough offers to buy to satisfy the sale. If they wanted to offer it all at a reasonable price, all they had to do was specify a limit price and wait for the buyers to show up. If they wanted to sell quick, they should have known there weren't enough offers to buy to satisfy their sale, so you'd have a market order that would fall to zero on them and somebody should stop that from happening.

    • by Ironsides (739422)

      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.

      Er, no. Martha Stewart went to jail for Obstruction of Justice. She was never convicted of anything else, including insider trading.

      • The obstruction of justice was the fact she faked the phone records, therefore destroying the evidence that would have led to a conviction on insider trading.
        • by Ironsides (739422)
          Got a source for that claim? I'm trying to figure out how she would have faked phone records that were not in her possession. The phone company holds records, not the caller.
          • by LostCluster (625375) * on Friday October 01, 2010 @08:16PM (#33767214)

            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: (Score:3, Interesting)

      by Lobachevsky (465666)

      You didn't point out that the OP gave a terrible summary. 75,000 sell orders were not issued; a single 75,000 e-mini contract sell order was issued by a single trader to the firm's execution platform (that slices and piecewise sells, rather than issue a single large sell to reduce market impact). The firm's execution platform ultimately sold 35,000 e-mini contracts in 7 minutes before the firm shut it down. The program did what it was instructed to do -- the trader made a fat-finger error of selling $

    • This isn't the true picture of what happened.

      The pit where this drama went down was JUST the S&P 500 e-mini futures pit. Here's the tick by tick and audio of the pit boss having a heart attack [youtube.com] over it. This was the pit where the fat-fingered trade happened. Actually, it wasn't exactly a fat-finger but a mistimed trade... it was supposed to take 5 hours to sell the futures off in small little bursts, but instead they "flooded the market with paper".

      This spilled over into the REAL stock exchanges whe

      • You can see the often-said argument that the Flash Crash caused Zero-Prints was due to insanely-low bid prices is not exactly accurate. Sure there was some crazy offers, but look at the trading volume.... it was all execution nonsense coming from the HFT trading systems that was flooding the markets with non-sensical orders.

        I kind of wish the exchanges DIDNT reverse the trades. It would have wiped out more than 3/4ths of all the HFT shops and sent them packing. Now I won't even dare put any IRA/401(k

  • So... (Score:4, Insightful)

    by rantomaniac (1876228) on Friday October 01, 2010 @04:55PM (#33765612)

    Remind me, why do we have such a fragile system at the very core of modern civilisation?

    • Re: (Score:2, Insightful)

      by Anonymous Coward

      Because the stock market is not civilized place, it's rigged by supercomputers. The idea that mankind is civilized is the falsehood. A civilized species would not engage in what mankind today engages in.

    • Because it works? (Score:5, Insightful)

      by Sycraft-fu (314770) on Friday October 01, 2010 @05:13PM (#33765796)

      Seriously. I think most people will admit it isn't perfect, and it looks like they are trying to improve the system as a result of this. However fundamentally, it works. It helps money move around more, so that businesses can get financing, individuals can invest and so on.

      The reason why you find that prosperous nations have things like a stock market and other capitalist features is because they work. Doesn't mean you ignore them or let them run totally wild, but fundamentally they get the job done, where as a command and control economy does not. While it may add instability it also adds flexibility and that is important.

      • Re:Because it works? (Score:5, Interesting)

        by jd (1658) <<moc.oohay> <ta> <kapimi>> on Friday October 01, 2010 @05:28PM (#33765928) Homepage Journal

        I'm not sure that the proposed solutions will fix the problem. I'd much rather a degradation in response times as a function of orders (so the more orders there are, the slower the system gets) rather than a temporary hold on that stock. Temporary holds assume that software won't do what it has always done in the past - try again until it gets through. If you flood the system with retries from enough computers, the results won't change. It will merely have short gaps in it. If you have gradual degradation, then flooding will slow things way down until the flood stops. The negative feedback loop will guarantee that a crash becomes impossible.

        In fact, that is something the market could do with more of - negative feedback loops. It should be possible to prevent market bubbles as well as market bursts, as a bubble is just a positive feedback loop in the opposite direction.

      • Insightful my ass (Score:5, Insightful)

        by SmallFurryCreature (593017) on Friday October 01, 2010 @05:34PM (#33765984) Journal

        Except that stock speculation has NOTHING to do with investment anymore. Wall street does NOT invest, it speculates. It is gambling on the minute by minute perceived loss and gains in the world with a hefty amount of making events happen.

        Take the recent event of a speculator simply buying up chocolate to drive up the price. What has that got to do with investment or making money go around? Nothing at all.

        You have the idea that the stock market is still the old idea of buying a share in a ships voyage when this was first made official in Holland centuries ago.

        Yes, if you buy shares in a company hoping to get dividend from it in the future, then you are investing. When you are shorting stocks on the difference in value over a period of minutes, that is NOT investment.

        Stop pretending that it is.

      • by houghi (78078) on Friday October 01, 2010 @05:54PM (#33766162)

        Just because something works does not mean it is a good idea. Ponzi schemes work.

        • by Sycraft-fu (314770) on Friday October 01, 2010 @06:31PM (#33766492)

          I mean it works in terms of making an economy work better. It provides a good way for people to invest and borrow money, which is important. A fundamental principle of money is that it has to move around to do anyone any good. It is just a construct to facilitate trade. Trading goods and services is what actually makes an economy worthwhile. Money is just a construct to facilitate that. Well that means money is only good if people spend it, if it moves around. The stock market is something that helps that happen.

          If you've a better idea, then it would be great to hear it. All I'd caution you on is to do some research, because as with many things in life there are economic solutions that are clear, simple, and dead wrong. A command economy would be one of those. People say "Why not just have the government control it all? It is resilient but can change quickly." Ya well, command economies have been tried numerous times and failed miserably because they don't deal with human nature well.

          As it stands, an open investment market is one of those things that helps economic efficiency. You will notice the US is not unique in it.

          • I don't think GP is rallying against stock markets in general - those have quite a history, and mostly worked fine. The problem is with specifically with high-frequency automated trading, which doesn't make any economic sense except for filling someone's pockets with money, doesn't serve any societally beneficial goals, and is actively harmful to legitimate trade.

            • To me it seems like an attack against stock markets because that would be the "fragile system at the very core of modern civilisation?" High frequency trading is a different issue, and was just something that evolved because of the market and computers. The market wasn't designed to stop it, so it happens.

              My bet is he's one of the many people who hang out here that dislike capitalism and like communism because they don't understand either very well. They see the flaws in capitalism because, well, when you l

        • No, no they don't.

          They "work" for a short while, then they explode.

      • by gethoht (757871) on Friday October 01, 2010 @06:09PM (#33766304)
        Exchanges make boatloads of money off of High Frequency Traders(HFT). While their algorithm mows through a ton of investors stops, causing thousands of people to lose money, their algorithm gets the benefit of the doubt as any trade after a certain percentage swing gets nullified by the exchanges. In short, they get play by different rules then other investors. The easiest way to stop all this HFT flash crash shenanigans is to declare all trades of a freaked out algo valid. Then the people responsible for that algo lose tons of cash, as they rightfully should. That loss should incentivize banks and their programmers from writing shitty programs that freak out the markets. As it stands right now the banks and their algos have a win win situation. They get to make millions when their algos work but when their algo's freak out, the exchange gets to declare the trades invalid. Make the trades the algo makes completely valid and I guarantee you won't see algos freaking out as often.
        • Re: (Score:2, Insightful)

          by RocketRabbit (830691)

          Another option would be to only allow value changes once per day. Then high frequency traders would be put out of a job and their manipulations would be for naught.

    • Re: (Score:2, Insightful)

      by copponex (13876)

      Because no one hates an honestly earned dollar more than the wealthy, greedy aristocrats that run Wall St. That's why they hate unions. That's why they hate regulations. That's why they hate the minimum wage. They sincerely believe that they are entitled to million dollar bonuses, and everyone else is meaningless.

      Their worst nightmare is having to go out and earn their keep. They want to continue gaming the financial casino, and having the middle class cover their bets when they lose. But since they've alre

    • Remind me, why do we have such a fragile system at the very core of modern civilisation?

      Define 'core of civilization.' I don't view stock markets as that kind of thing. Regardless, I believe the reasoning they allow it is that -- like everything else in that crazy place of Wall Street -- it can help you make or lose money. This wasn't the only investigation where an algorithm screwed up. I submitted a story that wasn't accepted [slashdot.org] about an algorithm that lost one company a million dollars in five seconds.

      So, you know, before you sign up to let a high frequency trader manage your trades,

    • Re:So... (Score:5, Insightful)

      by mrlibertarian (1150979) on Friday October 01, 2010 @05:33PM (#33765980)
      Fragile? The system may have "broke" in a flash, but it also fixed itself in a flash. The only people who were hurt were those who sold because everyone else was selling (stop loss orders).

      This entire issue boils down to a particular group of people whining about a single firm's stupid computer algorithm, because that algorithm broke the stupid computer algorithms that group relies on (i.e. stop loss orders). For value investors, this whole thing is just a bunch of noise. Civilization rolls on.
      • by ceoyoyo (59147)

        Too bad it didn't take a little longer to fix. By the time anyone who deserved to make money on it heard, it was too late.

    • "Capitalism is the worst economic system, except for all the others."

  • Ouch (Score:4, Insightful)

    by citking (551907) <[ten.gniktic] [ta] [yaj]> on Friday October 01, 2010 @04:56PM (#33765624) Homepage

    Hope the person(s) who wrote that algorithm aren't writing nuclear reactor code. I'll admit though that I'm a bad programmer too. Back when I did write code I used such gems as DIM TotalSales AS INTEGER. That didn't work so well.

  • a successful strategy to manipulate the entire stock market, then yes, I'm sure it was an "algorithm" that caused the problem. Now the algorithms can get down to business by creating several small unnoticeable dips during the day which can be exploited for a tidy, sustainable profit.

    Cheers!

    • by JWSmythe (446288)

          That's pretty much the whole stock market game. Take advantage of market fluctuations before someone else does. It doesn't matter if you create those fluctuations yourself or not.

    • a successful strategy to manipulate the entire stock market, then yes, I'm sure it was an "algorithm" that caused the problem. Now the algorithms can get down to business by creating several small unnoticeable dips during the day which can be exploited for a tidy, sustainable profit.

      Dumping shares below their market value isn't a very good way to pump the market.

  • They're both scams. Scams by the rich and established powers to prevent their apple-cart from ever getting upset. They are both extremely vulnerable and the respective lynchpins of critical parts of a developed country: the marketplace is the lifeblood of the capitalism, and voting is the core of democracy.

    I used to be sure we lived in a capitalist democracy. Now I'm no longer sure. With the front-running and voting scandals, with enough "people being taking out of the loop", how do we know what's real an

  • by roman_mir (125474) on Friday October 01, 2010 @05:28PM (#33765934) Homepage Journal

    High Frequency Trading algorithms are most likely written by a very small number of people, who probably even know each other. The approaches to creating these algorithms should be very similar.

    So it should not come as a surprise that given the same set of market data (news/some stocks going up/some going down/interest rates velocity/housing data/confidence/M1/Mx/etc.) the algorithms used by different HFT houses would respond in a similar fashion.

    Imagine HFT House 1, 2, 3.

    Now if one of them (1) noticed the market data at the same time *(and they saw that Japan was doing something funky with currency at that time) it started calculating probability of stocks going up or down and decided to play it safe (which at that time meant moving out of equities and commodities into cash), so it started to sell.

    Now the other one (2) noticed the same thing about the market and noticed that (1) is selling, so it (2) upped the probability that stocks will go down and also decided to 'play safe' and started moving into dollars.

    Same with the last one (3).

    Now everybody is trying to sell at increased velocities. First they do their normal 5000 transactions/second post and cancel routine, but eventually they would actually stop canceling, prompting the rest of the market to start selling, triggering the automatic retail stops etc.

    The HFT algorithms are really synchronized when it comes to overall data and they magnify the resulting movement by each others' actions.

    BTW., you'll soon notice that bad news will no longer cause stock markets to go down, but instead they'll go up and so will commodities, that's because it is now recognized that bad news = more quantitative easing = more inflation = weaker dollar. So who wants to buy dollar on bad news, if bad news really means that the Fed will print more dollars? Same with bonds, buying bonds is stupid, they'll eventually figure it out. Buying bonds is like buying dollars to be received a number of years into the future. BUT if you don't want dollars that are inflating NOW, why would you want the inflated dollars in the FUTURE? Makes no sense, so bonds will also go down upon bad news eventually.

    You can see these mini flash events caused by HFT in different market segments through the day, if one bank goes down in a very short time frame, then you can be almost certain that most of them went down by the same amount, and then they'll all come back to almost the original levels minus the retail auto stops that'll be eaten. Don't be a sucker, move your money to commodities or foreign equities.

    • by roman_mir (125474)

      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% -

  • by Anonymous Coward on Friday October 01, 2010 @05:42PM (#33766034)

    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."

  • by rickb928 (945187)

    "said they expect the results of the investigation to prompt additional rules limiting the functions of automated computer trading systems"

    And why not START here?

    As if we need or can benefit from automated trading, on the scale both in time and money that these systems did. It's both thievery and fraud: Thievery by deriving profit from a system by manipulating the market in a way that should be offensive to real people, and fraudulent because it operates in a way that deprives an actual person from either

    • by Z34107 (925136)

      Why are you "no longer sure" you want mutual funds? If your complaint is the Common Man(tm) doesn't have low-latency supercomputers, you better give your money to someone who does. Or find a mattress with good yield.

      • by rickb928 (945187)

        The system doesn't just permit machine trading, it encourages it. While this incident is about futures, and I can't imagine investing in futures, there is very little difference between these platforms and machine trading in common stocks. Mutual funds are part of that system,and since the Stock Market is, IMHO, becoming even less realistic than it has been, I'm wanting some other opportunity for investment. I have no idea what that is yet.

  • by Animats (122034) on Friday October 01, 2010 @06:04PM (#33766228) Homepage

    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.

    • Re: (Score:3, Insightful)

      by LostCluster (625375) *

      First, none of this involved a "bug" . All systems involved functioned as designed.

      A program that runs as designed but produces a undesirable result has a "design flaw" which is a class of "bug". Such things need to be "fixed".

      • by 7-Vodka (195504) on Saturday October 02, 2010 @04:06AM (#33769068) Journal

        A program that runs as designed but produces a undesirable result has a "design flaw" which is a class of "bug". Such things need to be "fixed".

        What program are you talking about? If you read the parent post you will notice that no single program had an undesirable effect. The market as a whole entity was what failed, the failure was not in any individual program.

        If you want to know what I think, the market didn't fail. What was a failure was the response of freezing markets and reversing trades.

        Those trades were made by consenting adults in good faith or the trading systems that they entered into willingly. Money was lost and money was made. Fuck anyone who got burned, that's a normal day in trading. Or it should be, but unfortunately if a enough big players lose enough money they reverse the trades for them.

    • I'd say something did go wrong. While a $4 billion sell order is not overwhelmingly large in some markets, in the e-Mini market, those 75,000 contracts will overwhelm the standing bids if dumped on the market too fast. And that's what happened, due to the retarded algorithm that targeted 9% of trading volume *without regard to price*. In today's environment, that algorithm is broken because high frequency traders swarm as soon as the market starts to move. HFT is not a problem per se, they mostly just buy a

    • by Required Snark (1702878) on Friday October 01, 2010 @07:38PM (#33766992)
      The key line is:

      Whether or not society should support an "efficient market" system to this extent is an question one is not supposed to ask.

      The algorithm didn't fail, Wall Street as an institution has failed. The simplistic view of why capitalism works is that individuals and institutions making informed decisions results in good allocation of resources. The profitable thrive and the unprofitable die, and on the whole society benefits.

      None of the preconditions for capitalism exist in the current setup. The big entrenched special interests change the nature of the system so that they take profit and are shielded from risk. The technical term for this is "moral hazard". The TARP bailout is the perfect example of this. All the big Wall St. firms made huge amounts of money by playing insider games with mortgage back securities (MBS) and collateralized debt obligations (CDO), and then when their gambling resulted in failure, the were bailed out to the tune of ONE HALF TRILLION DOLLARS, and the government is left with the bad assets. And the people who caused the mess are still in charge and got to keep all the money they stole during the bubble, as well as the money they got from the Treasury. Does the phrase "moral hazard" seem sufficient to describe this behavior, or would "rape, pillage and burn" seem more appropriate?

      Programmed high frequency trading (along with hedge funds) are another mechanism for taking wealth from the system that breaks the capitalistic model. The claim is the it "increases fluidity" and therefore make the market "more efficient". The plain English translation of "more efficient" is theft, and "increases fluidity" is like saying "magic pixie dust".

      The real world value of a company cannot change at millisecond resolution. The only things of economic value that change that fast are electronic abstractions of money. Therefore, high frequency trading is completely disconnected from real world value, so no capitalism is involved. The system is built so that insiders can become personally wealthy because they are the insiders, not because they do an efficient (good) job of allocating resources and benefiting society.

      This is identical to the MBS/CDO monstrosity, in that there is no clear real world description of how value is created. For MBS/CDOs there was a lot of math that no one making decisions really understood, but somehow mortgages from buyers who were previously unqualified could become AAA securities. For flash trading there is "fluidity" and algorithms that traders don't understand. It is the same kind of scam.

      As long as the stock market allows high frequency trading it will be intrinsically unstable, because this kind of trading is about manipulating the abstract system, not about real world issues. No set of rules will change things, because computationally based trading is about taking advantage of rules to get advantage via manipulation.

      The only kind of rule changes that will help are things like increasing the cost of individual trades or keeping electronic traders from placing trades that they cannot or do not intend to make. (Trading algorithm determine price points by placing lots of orders and seeing which ones get responses.) Or electronic traders must be forced to honor trades or hold assets that they are trading, so they are exposed to the market risks of the underlying securities. Right now there is no cost for these traders for any manipulative practices, which effectively decouples risk from reward. All these kinds proposals move this kind of trading back towards actual capitalism.

      It will be very hard to get meaningful changes to high frequency trading because the powerful and personally corrupt Wall St. insiders don't want a capitalistic system, they want their guaranteed profits. It is much closer to a Mafia style protection racket then a system that enables real business activity.

    • The problem is that the derivatives markets settle in cash and not in the underlying security. They are essentially side bets on the prices in the real markets. The derivatives markets can be many times the size of the real markets and the tail (the derivatives) can wildly wag the dog (the real markets). If futures and options were required to settle in the actual security, the frantic trading would be inhibited. An option to buy or sell stock or a contract for future sale or delivery of stock would nee

  • by alexmin (938677) on Friday October 01, 2010 @06:07PM (#33766266)

    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.

    • 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.

      The reason why the NYSE slowdowns didn't help but rather hurt was because they weren't honored by the electronic exchanges, which saw sells and buys and matched them as fast as they could with no slowdown or any sort of review.

      Where's Clippy when you need him? "You're about to delete hundreds of millions from you're firm's value! Are you sure you want to continue?"

  • There's lots of gaming going on with high frequency trading, or really high frequency price pinging, bids and asks which are tossed out and canceled to simply mess with the quote queues. High frequency algorithms can flood the queues to get artificial imbalances and quote delays. There might even be some arbitrage possibilities based on differences between different quote systems time stamp transactions. Some timestamps are the time of the quote when queued, and others are the time the quote leaves a queue.

  • The real crime here was not the market orders that were improperly executed. The real crime were all the subsequent day or GTC limit orders that were triggered by the plunge that were executed at the artificially low prices. Remember that many brokerages can fill customer orders without going to the market - they can use the current market price tick, but execute the trade from their own inventory. Thus, the price does not change due to the trade, bypassing market buy/sell corrections. This was another
  • http://www.zerohedge.com/article/sec-releases-final-flash-crash-report-waddell-and-reed-blamed-selling-catalyst [zerohedge.com]
    has a good easy to understand news on this.
    then news like this http://arstechnica.com/tech-policy/news/2010/09/first-nyclondon-cable-in-a-decade-promises-sub-60ms-latency.ars [arstechnica.com]
    hints at "just to give its high-frequency trading customers a few milliseconds of advantage over the competition."

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