SECURITY

Flash Crash: Unhappy Anniversary

Joe Maglitta | Date: 05-12-11 | Comments

Are smarter technologies the problem or the solution to wild financial market fluctuations? Yes. Experts say smarter technology requires smarter regulation and public policy.

Table of Contents:

Flash Crash: Unhappy Anniversary
The obligatory public soul searching following the first anniversary of Wall Street�s �Flash Crash� raised key questions for technologists, lawmakers and investors.

Is the smarter trading technology behind the meltdown a brilliant game-changer? Or a financial weapon of mass destruction wielded irresponsibly by greedy bad actors? Is smarter technology the problem or the solution? Are our 401(k)s, pensions and other investments more secure today? Or are they more vulnerable?

Yes to all.

A year after the fastest plunge in S&P 500 history, a wide range of players including the Securities and Exchange Commission, Wall Streeters, academics and various tech experts agree that super-smart, super-fast, super-stealthy trading algorithms enabled the crash.

The face of evil? Or super-smart technology? Close-up of a suspicious stock market �robo� algorithm at work. Similar programs can generate thousands of transactions per second. (Source: Nanex.net)

"High-frequency traders turned what was a very down day for many investors into a very profitable one for themselves by taking liquidity rather than providing it," U.S. Securities and Exchange Commission Chairman Mary Schapiro said at a recent conference.

Most also agree that smarter market auditing and monitoring technology, along with modernized regulations, are needed to quell the inevitable repeats and mutations already jittering global stock, currency, commodities and futures markets.

On the plus side, electronic trading has shortened settlement times, lowered bid-ask prices for frequently traded stocks, reduced brokerage costs and improved the flow of information, Forbes notes. High-speed computerized trades account for around 50 percent of all trades. That accelerates upsides and generates huge profits for stealthy traders. But experts say it also can manipulate markets and amplify dangers.

Robert Claassen, a capital markets attorney at Paul Hastings Janofsky Walker, told The Street, "The truth is that the Flash Crash was caused by these black boxes that hedge funds had that automatically made trades.�

In one of the best analyses of the crash, market data aggregator Nanex explains: The buyers of the Waddell & Reed e-Mini contracts transformed a passive, low-impact event into a series of large, intense bursts of market-impacting events which overloaded the system� promoting the �freak sell-off.�

In other words, smarter tech quickly turned a trading trickle into a disastrous flood.

After the crash, regulators went to great lengths to calm investors and restore shaken faith in the system. The Securities and Exchange Commission introduced single-stock circuit-breakers on the Russell 1000 that impose a �time-out� whenever unusual trading swings stock too wildly. A �limit-up, limit-down� mechanism is planned to keep trades in a specified price band.

Next: More Crashes to Come >>