If “flash” does not refer to the practice of studying “flash” order flow to the likes of JPM, Goldman (who allegedly does over 60% of the trading on NYSE, I would attribute the sudden loss of bids to the more modern type of technical analysis and execution called “high frequency trading”. That means trading much more often, in smaller lots, for tiny profits. Like, the old saying: “If you can’t make your numbers on margin, than make it up on Volume”.
Much of that fast trading is called “latency arbitrage”, or profiting on tiny differences in price predictable if your data feed is faster than somebody else’s, and your orders can be placed on the exchange faster than somebody else’s. It helps it you have no fundamental need to buy or sell other than to play the tiny fibrillations of price. I call it “Trader Tetris”. It’s like those old computer games where you “take out” blocks of whatever impedes your progress to the higher score.
One way to arbitrage latency is: rather than get a technical analysis “signal”, then place your order, then go to the back of the line at the exchange and wait for your order to be filled, you put bids and offers on the book above and below the NBBO inside bids and offers, and with an exchange co-located trading server, you cancel whichever side is opposite the side you want to trade. Since you created the hole before other traders’ orders were “up to bat”, you have made a short term impact by removing support or resistance before others can even see it or respond to it. The price can gap right through the hole on low volume. You can collect the market maker rebate as a bonus even if you happen perchance to trade with your own dark pool subsidiary at break even. By canceling one of two opposites instead of placing a one sided order, your latency is reduced because you do NOT have to wait for your standing orders to be canceled! The remaining standing orders are also like the tetris blocks with which you stop your competitor from bidding or offering quickly before you do. Voila! Now you see them, now you don’t! The bids and offers can disappear instantly as a “reverse order flow”.
I think people got used to the liquidity provided by these high frequency traders, and when the foreign exchange markets got too crazy, the high-volume fast stock traders just pulled their standing market maker liquidity and there was a sort of “vacuum” suddenly. That would leave a huge hole in the depth of market and set off an algorithmic chain reaction, particularly if it happened so fast that standing stop loss orders placed below the expected trading range for those unlikely “black swan” events got hit for no sound technical or fundamental reason other than a misjudgment of the impact of automated programmed trading under unforeseen and untested circumstances.
I also think that the instability was exacerbated by a lack of normal investment buying order flow compared to the currently normal (lately of greater proportion due to ‘HFT’ and latency arbitrage than previously normal) volume of in and out trading order flow, probably combined with lack of supervision of trades by human traders, who certainly have more common sense than computers which are issuing orders as fast as they can, even faster than the exchanges can digest them.
I am not a very experienced trader; I come from a systems engineering background. I happened to have recorded (and saved without refreshing the data) that flash crash tick by tick (Tradestation actually kept up very nicely, except for one minute or so near the climax) To me as an engineer, the price action looked like a classic system overload saturation event, or “clipping” distortion due to lack of dynamic amplitude handling capacity, and resulting loss of the usual negative feedback stabilizing efficiency normally existing in the markets.
If there are any conspiracies here, I will guess that they might soon come to light in the government hallways when lawmakers try to find new rules to better “regulate” the newer (“unfair”) computer trading technology and the resulting opportunities for deploying new trading strategies which can scoop the markets. If you ask me, real conspiracies are what we watch competing for the Stanley Cup in the playoffs lately. I’m from Michigan, I was rooting for the Detroit Red Wings.
Ah, we also watch the thrilling bareback rides of unbridled free enterprises and their “robber barons”!
When the biggest government-funded investment banks boasted publicly of their quarterly “perfect” runs of no days with trading losses, I thought to myself: “Pride goeth before the fall”……
Personally, I vote for prohibiting abuse of excessive leverage and abuse of “fake” liquidity (courtesy of TARP, even) that is so transient and practically unusable that it has no real benefit, or even is hazardous to the physical economy, and then diverting the evacuation and cleanup bill from the perpetrators to the innocent taxpayers when the reactor core melts down from thermonuclear runaway like Chernobyl.
But it could already be too late to stop that now. I learned THAT back when I “minored” in Economics in college back in the early ’60s, and after then got my MBA at U. of Mich. They came up with the Glass Steagall act(s) only 30 years before my college days when the horses had already escaped from the barn, so “it” would not as likely happen again. (deflationary collapse due to over-leverage and (risk) abuse of bank depositors’ funds, among other things) and “The Rest of the Story”.
Sometime in the 1990s, Bill Gates achieved his goal of
Lyle 6:32 PM on May 16, 2010 Permalink | Log in to Reply
Teresa, I am surprised no one has commented. You make it sound so easy, but I KNOW it is not. I want to thank you for being the one, like in an old Hollywood movie, wearing the white hat. Or as I think of it a bit more; think of the last Hollywood Die Hard remake. You Know “The Guy,” that makes things safer for anyone listening. You can’t help everyone just those that are listening. Thank you for being too nice.
Teresa Lo 2:01 PM on May 17, 2010 Permalink | Log in to Reply
I guess people just want more exotic and new “explanations.”