The crash of 2:45, which is otherwise known as the May 6th 2010 Flash Crash, was a stock market crash that happened in the United States on Thursday, May 6th, 2010. During this event, the Dow Jones Industrial Average plunged roughly 1000 points or almost nine percentage points, recovering these losses within a period of minutes. This was the second greatest point swing and the greatest single day point decline in Dow Jones history. The swing of 1,010.14 points and the decline of 998.5 points was among the most devastating in the history of the Dow Jones.
On the date of May 6th, the U.S. stock markets opened down and continued to trend down throughout much of the day on concerns about the Greek debt crisis. At 2:42 in the afternoon, the Dow Jones was down by more than 300 points for the day. At this point, the equity market began falling rapidly. A drop of greater than 600 points happened in roughly five minutes, totaling up a nearly 1,000 point loss during the day that up to 2:47 PM. Then the market made a marked recovery, regaining most of the 600 point drop of the previous hour by 3:07 that afternoon, a mere 20 minutes later.
After a period of nearly five months of thorough investigations by the United States’s Securities and Exchange Commission or SEC, and the CFTC or Commodity Futures Trading Commission led by Gregg E. Berman, the two government agencies issued a joint report on September 30th, 2010 entitled “Findings Regarding the Market Events of May 6, 2010.” This report identified a series of events that led up to the Flash Crash.
According to the joint report, the market at that point was so fragmented and easily destabilized that only one large volume trade was able to send tremendous shock waves throughout the market. The market went into a dramatic spiral, and the report laid out details about how a large mutual fund firm had sold an unusually large amount of E-Mini S&P 500 contracts and went through all of their available buyers before subsequently going through high frequency traders or HFTs. After them, the fund company aggressively sold their contracts, further accelerating the effects of the total sales volume and contributing to the dramatic price declines of the day.
According to the CFTC and SEC joint report, May 6th began as a particularly turbulent day for the general market. Beyond the early turbulence, the early afternoon began a trend marked by highly negative market sentiment and dramatically increased price volatility and a decrease in liquidity. As the day wore on, a large mutual fund complex that traded actively began to sell a total of roughly 75,000 E-Mini S&P 500 contracts that carried a total value of around $4.1 billion in order to hedge its then existent position in equities. According to the report, this position was an unusually large one, and the algorithm the trader initiated on the terminal aimed to target an execution rate set to 9% of the previous minute’s trading volume without giving consideration to the factors of time or price.
While the larger seller’s trades were being executed over the market for futures, a sizable number of buyers emerged. These included high frequency trading firms of the type that specialized in higher speed trading and that seldom hold on to any type of position for an extended period. Within minutes of the original trades, these high frequency trading firms also began to sell the long futures positions they had acquired primarily from the mutual fund with tremendous aggression. According to the Wall Street Journal, the HFTs subsequently began to buy and resell contracts to one another in a rapid basis. The volume effect was actually compared to the children’s game of ‘hot potato.’ Between the high frequency firms and the large seller, the price of the E-mini went down by 3% within a period of only four minutes time.
The SEC and CFTC report itself claimed that because of the tremendous selling pressure from the Sell Algorithm, the HFTs and the other traders, the price of the E-mini S&P 500 went down by roughly 3% in only four minutes between the time of 2:41 PM and that of 2:44 PM. Along this same time frame, the arbitrageurs who operate across the market also bought the E-Mini S&P 500 and sold a roughly equivalent amount of them in the equities markets. This in turn drove the price of the exchange traded fund known as SPY, representing the entire S&P 500 index down by a roughly equal 3% amount.
Across all of this, the demand for this was still lacking from more long term fundamental seeking buyers and cross market arbitrageurs. Because of this lack of solid demand, the HFT companies started to rapidly buy and then rapidly resell contracts to one another in what was described as a hot potato effect. This occurred due to the extremely rapid nature of the trades taking place between the HFTs. During a period measured in seconds between 2:45:13 PM and 2:45:27 PM, these HFTs actually traded more than 27,000 contracts among themselves. This amount accounted for approximately 49 percent of the total trading volume during that larger period. Meanwhile the net amount of additional contracts the group bought were only 200 extra.
While the prices throughout the futures market fell, the entire equities market experienced a spillover effect as a result of this high volume and rapid price change. As the high frequency trading firms used their computer systems used their computer systems to keep track of all the market activity to determine when to trade. As this group decided to temporarily cease their trading activities, they either scaled back their trading for the time being or completely withdrew from the markets.
According to a story in the New York Times, the joint report from the CFTC and the SEC also noted that the traders who were using automatic computerized algorithms exited the stock market. As these traders ceased their trading activities, the lack of market liquidity that immediately resulted caused the shares of a reasonable number of higher profile, prominent companies such as Procter & Gamble and Accenture to trade downward between prices of $.01 and those as high as $100,000. With such extreme prices temporarily ruling the market, the market internalizers routed most of their money to the public markets. While these market internalizers are normally the companies that typically trade their customer orders using only their own inventory instead of relying on the markets, on this day they decided to put nearly all of their retail orders through the public markets. This large influx of additional selling pressure served to further diminish the already greatly reduced level of liquidity present in the market.
As some of the firms got out of the market, the other kinds of firms that stayed in further worsened the price declines of that day because they escalated their most aggressive selling practices as the downdraft continued. As both the high frequency firms and the other kinds of firms were net sellers, the crash happened due to a general lack of demand.
According to the joint report, the prices no longer continued to fall when at 2:45:28 PM, the trading of the E-Mini went to a state of pause for a period of five seconds due to the Stop Logic Functionality of the CME or Chicago Mercantile Exchange. This Stop Logic triggered as an automatic response designed to prevent a further, uncontrolled cascade effect of price dropping. As this period of time occurred, the sell side pressure of the E-Mini was partially eliminated and the buy side interest grew. As the trading resumed at 2:45:33 PM, the prices went back to a normalized level when the buy side interest increased. As the E-Mini began its recovering cycle, the SPY also followed suit and stabilized. As the New York Times reported, the rout went on until the automatic stabilizing algorithm on the futures exchange cut off and paused all of the trading for a term of five seconds. After the cooling off period, the market recovered quickly.