Flash Crash
Information and Regulatory
challenges
May 6, 2010
11,000
1,180
1,160
10,800
1,140
10,600
10,400
1,100
1,080
DJIA
10,200
1,060
E-Mini S&P 500
10,000
1,040
S&P 500 Index
9,800
1,020
8:30
9:20
10:10
11:00
11:50
Time
12:40
13:30
14:20
S&P 500
DJIA
1,120
May 6, 2010 e-mini
90000
1180
80000
1160
70000
Volume
1140
Price
60000
50000
1100
40000
1080
30000
1060
20000
1040
10000
0
1020
8:30
9:20
10:10
11:00
11:50
Time
12:40
13:30
14:20
15:10
Price
Volume
1120
E-Mini Narrative (CDT)
• It was stormy morning, stocks down
• 13:32 Large seller hedging equity position in the e-mini
with a sell program looking for 9% volume participation
• 13:42 high frequency traders buy and then sell and then
sell and sell in the cash market
• 13:45 “hot potato” passed around increasing volume and
program sells
• 13:45:28 5 second pause in e-mini
• 13:45:33-13:45:58 prices stabilize
• 13:46 fundamental buyers back in
• 14:08 price up to 13:32 level
Stock Narrative (EDT)
• Though e-mini crash stopped by 2:45 sell orders to
individual SP500 equities and ETF’s continued to
cash market which had been slowed down by very
high message traffic
• “Market Makers” backed away from cash markets
leading to trades at “stub quotes”
• By 3:00, most stocks close to their 2:00 levels
• Between 2:40 and 3:00 20,000 trades at prices 60%
away from their 2:40 level
• Finra and the exchanges agreed to break such trades
HFTs
• High frequency traders do not necessarily
trade so fast, but they do quote fast, with
quotes responding to new information (or ?)
• They are, in part, unofficial market makers
providing quotes (liquidity) to those who
wish to trade
Economics of Market Making
• Market makers make money by buying at
the bid and selling at the higher offer
• Costs of market making
– Opportunity costs
– “risk” costs-cost of inventory value fluctuating
– Providing quotes to traders with superior
information
Information and Market Making
• On average, a market maker loses money when
selling to an informed buyer and buying from
an informed seller
• After an informed buy the level of the quotes
will change so that buying at the bid and
selling at the offer need not lead to a profit
• Wider spread must be maintained to
compensate for losses to informed traders
Information
• The width of the spread between bid and offer
is a function of how much difference in
information there is between informed traders
and those making a market
• HFTs maximize the amount of information
they have by processing information on many
different securities
• Ability to respond to information (low latency)
means they can quote tighter spreads
Order flow information
• The information can be directional but can
also give an indication of whether there is a
lot of potentially informed trade
• Indication of aggressive selling signals both
a direction and the possible presence of
informed trade
– Drop bid price
– Widen spread
Market Breakdown
• If market makers have reduced information
and/or indication of very aggressive trading
the optimal action may be to stop quoting
– Or use stub quotes of bid $.01, $100,000
offered
Back to 5/6/10
• An apparently very large sell program starts in
the E-Mini
– 9% of previous minutes volume
• Natural escalation but not a big deal
– No limit price attached (unpriced)
• Who could have private information about the
entire economy? but Who would be crazy
enough to send in such orders if they did not
have information?
CME market makers
• CME market makers build up positive
inventory which they seek to hedge, fast
and aggressively in the cash markets
– SPY, other ETF’s and individual stocks
• Seek to unload e-mini futures to others who
also try to unload as price drops
– Increase in volume increases the aggression of
the original sell order making market
participants more nervous
Listed stocks
• Market makers in listed stocks (NASDAQ
and NYSE) trade on Archipelago, BATS,
KNIGHT, etc
• Algos see very aggressive sell orders and
attempt to respond to information
• Flood of orders, order changes and
cancellations clog up the system,
particularly at NYSE
Lack of Information
• Trades are reported through one system
(CTS) while quotes are reported through
another (CQS)
• Massive number of quotes and cancellations
means quote information delayed relative to
trade information
• See trades without corresponding quotes
– What is going on?
Shut it Down
• Many HFTs decide not to play and wait and
see
• CME calms down but takes longer for
information to be processed in the equity
markets as quotes are delayed
• Which finally calm down as well
CME v NYSE
• According to CFTC, HFTs not responsible
– They did what they have always done
– Both make and take liquidity
• Appears to have been withdrawal from
equity markets
• So story seems to be different
• Why?
Is my story true
• Not inconsistent with joint CFTC/SEC
report
• What we really need is more data
• SEC agrees and actually proposed this
before the flash crash
SEC information proposals
• Rule 13h-1 under the authority of 13(h) of the Exchange (34)
Act
– Requires large traders (2mm shares or $20mm in a day or 10x that
in a month) to be registered with unique identifier assigned by SEC
– Broker/Dealers must keep record of ID and time stamp of all
executions by a large trader
– Broker/dealers report large trader information through the
Electronic Blue Sheets upon request
• This will allow SEC to
–
–
–
–
Assess impact of larger trader activity
Reconstruct trading activity following unusual volatility
Analyze significant market events
Do they have the capacity to analyze the data?
Changes to Rule NMS
• Rule 613 (proposed, not adopted) of Reg
NMS would require exchanges to construct
repository for data on all trades and quotes
by client (not just clearing broker)
– Not just trades but quotes
– How will SEC process data?
Reason for rule change
• Clearing is handled, for most transactions,
at the broker level
– Only info reported to FINRA is representing
brokers, not clients
– Only info on quotes is “top of the book”
• Best bid and offer and size at best bid and offer
• SEC can get client information, but requires
request and response by broker
A lesson
• If you are trading equities, always use limit
orders with reasonable limit prices
• You may not trade right away, but it can
prevent very disadvantageous trades that
will not be broken
Speculation
• One company, Nanex (nanex.com), thinks
there was and is something more sinister
going on
• flood of message traffic disrupts market
– For example quote and quote cancellations at
very high volume lead to other machines
getting out of the market leaving a wide bid ask
spread and source of quotes buys at low bid and
sells at high offer
Is broader band needed?