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Flash Crash

High Frequency Trading and the 2010 Flash Crash

The 2010 Flash Crash was one of the shortest stock market crashes in history, clocking in at approximately 36 minutes. Although most people haven’t heard of it, it did result in congressional hearings to determine the cause. The culprit, at least in part, was High-Frequency Trading.

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HFT stands for High-Frequency Trading. It involves using powerful computers to engage in high-speed trading. These trades are based on algorithms programmed into the computer so that trading is entirely automated. This strategy trades large volumes to make a small profit, relying on the algorithm to succeed in the face of the risk.

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Did HFT Cause the Flash Crash?

Most of the time, HFT doesn’t leave a noticeable impact on the charts. Sometimes, however, it is quite the opposite. On May 6th, 2010, from 2:32 PM in just over half an hour, the stock market crashed and recovered. It is often referred to as the Crash of 2:45.

The crash occurred in the equities markets; the S&P 500, the Nasdaq, and the Dow Jones Industrial Average. The DJIA, for example, fell almost 1,000 points from its opening value due to the Flash Crash. This was approximately 9% of its total value, and it took only a couple of minutes. Even more unusual is the recovery that followed. By just past 3 PM, or about a half-hour later, most of the price drop had recovered. In another half hour, the price was in the same range as it was before the crash.

This crash, however, was not all due to HFT. In the aftermath of the event, there was quite a lot of research and debate about how much HFT and other factors played a role in the crash. When the dust settled, the CFTC concluded that HFT did not initiate the flash crash but did exacerbate the problem.

Other Reasons For The Crash

The cause of the problem was most directly pinned on a trader named Navinder Singh Sarao. Sarao was accused of many forms of market manipulation related to this event. Sarao had made the equities markets look strong and full of buyers. He used manipulation methods such as spoofing, layering, and front running to fake orders. Then he shorted those markets, so as it fell, he would profit.

His ploy was impressive, considering he was a lone man in his 30s working from his parent’s modest home. Blaming this man is certainly valid, though some accounts note that this one person cannot be solely to blame, that everything was pinned on him to move forward more cleanly. Some analysts even purported that flash crashes are more common when the data is examined than we would expect.

Regardless of whether the 2010 Flash Crash was due to Sarao or HFT, was a natural occurrence, a technical or human error, or some mixture of these, there are enduring changes due to this event. Mostly aimed at stopping the sorts of market manipulation Sarao engaged in, manipulations such as front-running, spoofing, and layering are all illegal now. Last but not least,  Sarao was wrapped up in a civil case brought against him by the CFTC. He ended up having all the money stolen or lost in other investments.

If you’re looking to learn more about the topic, we recommend checking out this paper.

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