WHAT HAPPENEDAt approximately 2:45 on 6th May 2010 Prices on the UnitedStates stock market fell sharply only to recover minutes later.The Dow Jones dropped 600 points during the crash addingto 300 point drop that day(due to Greek debt crisis).Most of the 600 point drop was recovered within tens ofminutes.(The staffs of the U.S. Commodity Futures Trading Commission and the U.S. Securities and Exchange Commission. )Dow Jones – Important Index of the stock of 30 large companies that are representative of the United states economy. Represents state of market.
THE STOCK MARKETCharging Bull statue near Wall Street in New York symbolizes a Bull market - whereprices in the market are on a upward trend.
Stock Market - The market for the trading and issuing shares (company stocks) done via stock exchanges.Stock Exchange - Provides a services that allow securities (stocks, bonds etc.) and financial instruments to be traded. Ensures fair and orderly trading. Effectively disseminate data on theprices of securities.Stock exchange simulator:http://www.howthemarketworks.com/
STOCK EXCHANGEMajor financial institutions situated around world aroundworld. UK has London Stock Exchange.core roles: 1) Raise capitol for new firms by shelling a share(stocks) in the company. Primary Market 2)Prove a platform for people to sell and buy shares (stocks).Secondary MarketStock – A unit of ownership in a corporation entitling you to part of the assents and profits of the corporation.
Business raises money by selling Buys shares shares in the on the second company hand market Stock Business ExchangeBusiness pays Sells shares shareholders on the second dividend Member hand market of public Key Cash flow Dividend – Payment of a proportion of the companies earning to the share holders. Proportion Decided by the board of directors. (Cash amount per share)
FINANCIALINSTRUMENTSA document representing a legal binding agreement involvingMonterey value.S&P 500 – A market weighted Index based on the stock prices of 500 American companies. Representative of industries in the U.S. economy thus a good indicator of the U.S. economic market.S&P 500 contracts – Are future contracts that are traded as a bet on where the S&P 500 index will be in the future. The value of one of these contracts is $250 multiplied by the value of the S&P 500 index.
E-MINI S&PAND EXAMPLEE-MINI S&P – A smaller more affordable version of the S&P 500 contract. The value of one of these contracts is $50 multiplied by the value of the S&P 500 index.ExampleSay that E-MINI S&P is trading at 1000(S&P 500 index at 100points). Then the trader controls $50,000 of the S&P 500index stocks. As the index increases or decrease thecontract can be sold for more or less money.
HIGH-FREQUENCYTRADINGPowerful computerized trading tool that executes a largenumber of trades at high speeds.Algorithms used to used to monitor multiple market factorsorders are executed based on market state.Make pennies on each trade that accumulate. The faster thetrader the more profit is made.Provide liquidity to the market.Liquidity – The amount a security can be traded without a change in there price. A liquid security is one that can be bought and sold with ease.
INVESTIGATING THE CRASHNew York stock exchange 1979 - Santi Visalli
THE CRASHCaused prices of most of the 8000 securities on the marketdecline rapidlyPrices fell up to 15% in some cases.20,000 trades took place at the time of the crash were price60% away from the pre-crash values.Some trades occurred as high as $100,000 or as low as lessthan a penny.Prices retuned to pre-crash levels moments later.
CFTC AND SEC REPORT Official report on the crash by the U.S. government.(The staffs of the U.S. Commodity Futures Trading Commission and the U.S. Securities and Exchange Commission. ) Event 1: Unsettled market Safe premiums(safe assents e.g. gold) prices increased to protected against the Greek debt crisis. Euro declined rapidly the Dollar and Yen. Market volatility increased and Liquidity Replenishment Points triggered. Liquidity Replenishment Points - triggered by individual stocks. Takes triggering stocks of the market for a time to decrease the volatility.
liquidity of the E-mini future contracts had by 55% thatmorning. Volatile and illiquid market.Event 2: Sell AlgorithmA large trader executed a sell Program to sell 75,000 E-minicontracts. Done to hedge an existing position.Sell algorithms normally take into account price, time andtrading volume. This algorithm was set to only car abouttrading volume.Sell rate set at “9% of the trading volume calculated over theprevious minute”Stock was sold 15 time faster than a previous trade of thatsize. Flood of E-mini deceasing liquidity
Event 3: High-frequency tradingInitial contrast were absorbed by fundamental buys in thefuture market. They then left the market.High-frequency traders began to buy large amount E-minicontacts.Price of E-mini contracts dropped by 3%The High-frequency traders due to their nature did not holdon to there position stated selling to each other. Reportstates that a “hot potato” situation was created sold backand forth to each other. Sell volume increased algorithmspeedHigh-frequency traders dropped out of market.Liquidity further decreased and price of E-mini dropped 6%
No liquidity in E-mini market.Stop-logic on Chicago Mercantile Exchange trigged in orderto prevent a future price declined.E-mini market paused. Sell side pressure was alleviated.Market recovered Flash crash was over.OutcomeCircuit breakers were installed on the New York StockExchange S&P stock that are trigged when the stocks rise offall by 10% in a 5 minute period.
ACADEMICLITERATURETHE MICROSTRUCTURE OF THE ‘FLASH CRASH’(Easley, Lopez de Prado, & OHara, 2010)Provides supporting evidence that illiquidity caused thecrash as detailed in the CFTC report.Key points:Order flow toxicity an its role in the crash.Order flow toxicity – likelihood that “informed traders”(hedge funds, large human controlled traders) incorrectlyselect “uniformed traders”(HFT).(Easley, Lopez de Prado, & OHara, Flow Toxicity and Liquidity in a High Frequency World, 2012)
Illiquidity is unknowingly created.Use the VPIN flow Toxicity metric which provides measure ofthe liquidly that is being provided.When flow to toxic market maker forced out of market, feedback increase effect and liquidity is lost. (Easley, Lopez de Prado, & OHara, 2010)
Solution:“The creation of an exchange-traded „VPIN contract”Give market makers a means of measuring flow toxicityA way for HFT to hedge against being adversely selected,they could stay in the market an keep providing liquidity.CME ReportThe 75,000 E-mini trade was not the cause, it was withinregulation.High-frequency traders were not the cause, they help marketrecover.That no errors or misconduct was found.(CME Group, 2010)
REFERENCESCME Group. (2010). What Happened on May 6th? Chicago: CME Group.Easley, D., Lopez de Prado, M. M., & OHara, M. (2012). Flow Toxicity andLiquidity in a High Frequency World. Review of Financial Studies , 1457-1493.Easley, D., Lopez de Prado, M. M., & OHara, M. (2010). TheMicrostructure of the „Flash Crash‟: Flow Toxicity, Liquidity Crashes andthe Probability of Informed Trading. he Journal of Portfolio Management, 118-128.The staffs of the U.S. Commodity Futures Trading Commission and theU.S. Securities and Exchange Commission. . FINDINGS REGARDINGTHE MARKET EVENTS OF MAY 6, 2010 . Washington, D.C : U.S.Commodity Futures Trading Commission and the U.S. Securities andExchange Commission.