Flash Crash: Nanex Continues Criticism of SEC Conclusions

Nanex has released its May 6’th 2010 Flash Crash Analysis Final Conclusion:

First of all, the Waddell & Reed trades were not the cause, nor the trigger. The algorithm was very well behaved; it was careful not to impact the market by selling at the bid, for example. And when prices moved down sharply, it would stop completely.

The buyer of those contracts, however, was not so careful when it came to selling what they had accumulated. Rather than making sure the sale would not impact the market, they did quite the opposite: they slammed the market with 2,000 or more contracts as fast as they could. The sale was so furious, it would often clear out the entire 10 levels of depth before the offer price could adjust downward. As time passed, the aggressiveness only increased, with these violent selling events occurring more often, until finally the e-Mini circuit breaker kicked in and paused trading for 5 seconds, ending the market slide.

The first large e-Mini sale slammed the market at approximately 14:42:44.075, which caused an explosion of quotes and trades in ETFs, equities, indexes and options — all occurring about 20 milliseconds later (about the time it takes information to travel from Chicago to New York). This surge in activity almost immediately saturated or slowed down every system that processes this information; some more than others. The next sell event came just 4 seconds later at 14:42:48, which was not enough time for many systems to recover from the shock of the first event. This was the beginning of the freak sell-off which became known as the flash crash.

In summary, 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. The SEC report uses an analogy of a game of hot-potato. We think it was more like a game of dodge-ball among first-graders, with a few eighth-graders mixed in. When the eighth-graders got the ball, everyone cleared the deck out of panic and fear.

Zero Hedge reports the latest in an ongoing series of mini-flash crashes – Verifone on October 15:

Well, none really, suffice to say that we have just had approximately the 20th flash crash in the past 2 months (all in rehearsal for when Apple goes bidless). Don’t worry though – the SEC is all over it. And, after all this is to be expected when trading in a computerized, roboticized, broken market. But a point to consider: the NYSE decided to cancel all trades below $27.44, so to the unlucky human who bought at $27.43 tough luck. Of course, robotic readers who sold at that price: congratulations, the NYSE and SEC has your robotic back. We are now eagerly awaiting Monday’s ongoing flash crashes.

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Zero Hedge‘s take on the SEC report was:


aiCIO notes that the SEC report whitewashes the Exchange’s role in the Flash Crash, in a post titled The Saga Continues: Flash Crash Controversy:

Still, the report has brought a lot of this criticism on itself. The recommendations it does make, and even many of the conclusions it comes to, seem incommensurate to the problems of the crash. The fact that the NYSE’s computer systems couldn’t keep up with trading volume and printed delayed and inaccurate stock quotes? A couple brief references buried in footnotes and deep in the report saying things like, “we do not believe significant market data delays were the primary factor in causing the events of May 6.” And no harsh words for the exchanges or demands that they fix the problems.

What to do about the lightning-fast reselling of futures that certainly contributed to (and in Nanex’s analysis, caused) the Crash? It doesn’t say much. What about the upside of high-frequency trading, firms who actually stayed in the jittery market and provided liquidity during the Crash, only to have exchanges like the NYSE cancel their trades and cost them millions? The report codifies a byzantine set of standards for canceling future trades, but they seem too complex for most trader to take into account during real-time trading, and are fairly moot, since an exchange has the right to cancel any trade it wants to. So in the unfortunate event of a repeat crash, many traders might be so afraid of having their trades canceled again that they’ll simply pull out of the market entirely.

And finally there’s the the bigger question of What This All Means. “Despite the knee-jerk reaction on part of anybody who wanted to get on TV,” says Illinois Institute of Technology professor Ben van Vliet, a high-frequency trading expert who works with the Chicago Mercantile Exchange and CFTC, the report shows “that automated systems had nothing to do with it….There’s actually a much better argument that the reason the market came back so fast is automated trading systems. Automated systems, because they don’t trade on emotion, calculated the probabilities, [bought the undervalued securities] and that’s why things came back so quickly.”

One Response to “Flash Crash: Nanex Continues Criticism of SEC Conclusions”

  1. […] … but frankly I don’t see how that becomes an SEC problem. The Nanex critique of the SEC report has been discussed on PrefBlog. […]

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