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Author: yodaorange Big red star, 1000 posts Feste Award Nominee! Feste Award Winner! Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: of 465361  
Subject: SEC lays an egg on Flash Crash Date: 10/3/2010 1:32 AM
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Yesterday (10/1/10) the SEC and the CFTC issued their report on the 5/6/10 Flash Crash. It is 104 pages with lots of pretty multicolor charts that illustrate various aspects of the crash. After reading the report over, I started to write up the most essential points and post them. After further reflection, I decided that the SEC report and my summary of it were almost totally misguided.

Link to the SEC report:

http://sec.gov/news/studies/2010/marketevents-report.pdf

Factually, the SEC report is quite good and comprehensive in explaining various aspects of the crash. For the small minority of investors in America that enjoy learning about nitty-gritty details of what occurred that day, it is a worthwhile read. Exactly how many investors fit into that category? Let’s make an estimate. Let’s assume that 100 investors read the METAR board postings on a regular basis and would take the time to read the full 104 page report. How many non-METARites do you know that would be interested enough to read the report? I don’t see many hands. There are approximately 114 million US households. Let’s assume that half of them either have stock accounts, 401K accounts or some other interest in US equity markets. That gives us 57 million investors that “care” how US equities perform. (Yes, for purposes of simplification, I am assuming there is only one interested investor per household.)

Out of the 57 million investors, how many METAR like investors are there that will read the SEC flash crash report? Let’s be incredibly generous and say 1 million. I actually think it is closer to zero, but let’s assume it is 1 million. That leaves us with 56 million US investors that will only see news headlines on the SEC Flash Crash report.

My original summary was intended for the 100 METARites which I decided was the wrong approach. This new summary is intended for the 56 million non-METARites. Here goes:

1) The SEC totally, 100% missed the most important points to highlight to the masses. Most likely they did this on purpose to try and convince the masses that all is well or will be well with US equity markets. I do NOT think the SEC is so incompetent that they actually believe this to be true, but they have to put a positive spin on it. And no, it is NOT a Democrat or Republican issue. Chris Cox under Bush is the same as Mary Schapiro under Obama in this regard.

2) The SEC lays primary blame for the flash crash on Waddell-Reed placing orders to sell short 75,000 e-mini SP500 contracts. The contracts have a nominal value of $4.1 billion which is supposed to impress the naïve that it is a large number. In fact, on a typical day about 2 MILLION of these contracts change hands. So the 75,000 represent about 3.75% of average trading. Does anybody believe that an incremental change of 3.75% volume should crash the US equity markets? I don’t think so. Similar trades to this likely have been done hundreds of times before without causing a flash crash.

3) Waddell-Reed is basically a widows and orphans mutual fund manager that was trying to hedge an $81 billion equity position. So it is not like they were some wild eyed speculator using 100 to 1 leverage or doing naked shorting. What they were doing was 100% legal, 100% moral, 100% rational and probably prudent.

4) The SEC report should have come out directly and said they every single firm and exchange they investigated was acting legally, morally and rationally in their own self interest. The SEC did not directly say it, but the implication to the public is that Waddell-Reed is somehow the bad guy in the flash crash. ABSOLUTELY NOT TRUE. In fact, what the SEC should have said to the public was that there were NO bad actors involved at all. The markets were working 100% like people intended them to work. Nothing irrational about them at all.

5) The SEC did NOT lay out a definitive action plan to prevent another flash crash from occurring. The reason for this is simple. They have NO plan. The markets have changed dramatically in structure over the last decade or so. In the “old days” when all trades were physically done on the NYSE, you could easily have fixed a problem if it occurred in the markets.

6) These days, there are countless exchanges and “dark pools” where trading occurs. The NYSE specialists are now called “designated market makers.” In the old days, they single handedly had responsibility for maintaining an “orderly market” in issues there were responsible for. These days, there are really NO substitutes for specialists. The High Frequency Traders fill that role some of the time, but as we learned during the flash crash, they can and will simply stop trading if they feel it is in their best interest. Even if the Designated Market Maker wanted to maintain an orderly market, how can he do it on the non-NYSE exchanges and dark pools?

7) The SEC did get one aspect correct. Trading is best described as a marginally stable system. What we learned is that it is relatively easy to have the system go unstable and out of control. Think of a jet fighter flying 100 feet off the ground at Mach 1. If something goes wrong, you get a large earth crater in a few milliseconds. That is kind of what our markets have evolved to. Incredibly high speeds with not much margin for error.

8) If the SEC was honest and upfront with the masses, here is what they would say. “Welcome to 2010. This is how markets now work. We can not reasonably guarantee another flash crash will be prevented. Matter of fact, we suggest you plan on them as a normal part of the investing landscape. But don’t worry, we believe they have NO long term impact on the fundamentals of equity investing. If stocks irrationally flash crash again, they will shortly go back to their correct, rational prices.”

9) As a practical matter, I don’t know how to put the genie of “stable” markets back into the bottle. While it is theoretically possible to do, there is so much money involved, I can’t imagine rolling back the clock. Stated differently: “Dorothy, we are NOT in Kansas anymore. Tapping your ruby red slippers together three times will NOT take us back to the stable markets of Kansas.”

As you can see, my message on the Flash Crash aimed at the 56 million non METARite investors would deliver a very different message than what the SEC did.

If anyone is interested in technical nitty gritty details of the flash crash, I will publish that summary. However, after reflecting for a while, I think it is less pertinent than this summary. There is one other aspect that has changed since the flash crash. If someone wanted to use lets call them questionable techniques to game the market, it is a lot more obvious how to do it after all of the flash crash research came out. I have to think that enterprising investors are hard at work figuring our how they will use these to increase profits at any available opportunity. . .

Thanks,

Yodaorange
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Author: SuisseBear Big gold star, 5000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 340963 of 465361
Subject: Re: SEC lays an egg on Flash Crash Date: 10/3/2010 4:07 AM
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If the SEC was honest and upfront with the masses, here is what they would say. “Welcome to 2010. This is how markets now work. We can not reasonably guarantee another flash crash will be prevented. Matter of fact, we suggest you plan on them as a normal part of the investing landscape.


If this turned out to be the takeaway, "business as usual", why were trades almost arbitrarily cancelled after the flash crash?

And are they going to continue arbitrarily cancelling trades following future flash crashes?

SB



Nearly 21,000 trades were canceled in the ensuing weeks because the exchanges deemed them erroneous.

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Author: MrPlunger Big gold star, 5000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 340965 of 465361
Subject: Re: SEC lays an egg on Flash Crash Date: 10/3/2010 4:39 AM
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there were NO bad actors involved at all
...
[players acted] is in their best interest



The moral of the story seems to be that anyone buying a stock will only be able to sell it if some-one else wants to buy it. No-one is forced to or even has a moral duty to buy it.

It reminds me of the Milken Junk bond days at Lehman, who promised customers "we'll always be here to make a market for you in this junk".

Quite apart from Lehman's non-existence (but who can you sue?!) they didn't mention what the price might be ...


Plunger

(Who promises that he'll still be alive in 2250)

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Author: SteadyAim Big red star, 1000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 340966 of 465361
Subject: Re: SEC lays an egg on Flash Crash Date: 10/3/2010 5:22 AM
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If this turned out to be the takeaway, "business as usual", why were trades almost arbitrarily cancelled after the flash crash?

And are they going to continue arbitrarily cancelling trades following future flash crashes?

"Nearly 21,000 trades were canceled in the ensuing weeks because the exchanges deemed them erroneous."


Great question!

It seems to me that like Yodaorange says this kind of possibility is just part of modern markets. But ... surely the SEC should be trying to at least minimise the chances of it happening?

Cancelling so-called "erroneous" trades following the event just makes people more reluctant to step in next time, and encourages HFTs to stop trading, which makes the problem more likely to happen again. We can all see that the trades look unfair, but actions have consequences and the SEC, of all people, need to be thinking 2 or 3 levels deep here, not just stopping at the superficial level. If traders could rely on trades not being cancelled, they would implement algorithms to take advantage of this kind of thing, meaning that buyers would be stepping in when prices plunged.

If they want to protect private investors, my suggestions would be:
- no cancelling of "erroneous" trades
- all stop loss orders should include a limit price "sell if price falls below S but only if price is still above L"
- make all orders visible for a minimum length of time, say 0.1s or 1.0s

SA

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Author: katinga Big funky green star, 20000 posts Old School Fool Ticker Guide Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 340970 of 465361
Subject: Re: SEC lays an egg on Flash Crash Date: 10/3/2010 8:59 AM
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The WSJ Weekend Edition was totally fishwrap on this. I wonder if you could somehow post the above to the letters to the editor?

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Author: WendyBG Big gold star, 5000 posts Top Favorite Fools Top Recommended Fools Feste Award Winner! Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 340975 of 465361
Subject: Re: SEC lays an egg on Flash Crash Date: 10/3/2010 10:53 AM
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yodaorange, of all your excellent posts, this one is the best. I wish there was a "super-rec," because this post is worth 10 of most rec'd posts.

<I have to think that enterprising investors are hard at work figuring our how they will use these to increase profits at any available opportunity. . . >

Your suggestions?
Wendy

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Author: yodaorange Big red star, 1000 posts Feste Award Nominee! Feste Award Winner! Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 340977 of 465361
Subject: Re: SEC lays an egg on Flash Crash Date: 10/3/2010 11:01 AM
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SuisseBear wrote: "If this turned out to be the takeaway, "business as usual", why were trades almost arbitrarily cancelled after the flash crash?"

Suisse, several points:

1) The SEC and the exchanges DID arbitrarily cancel many trades after the flash crash. They set a limit of any trade that was off by 60.0% or greater. This was a pulled out of the air number. There was ZERO factual or scientific basis for choosing 60.0% IMO. What about the investor that lost 59.9%, yet his trade was allowed to stand? How can you justify that?

2) IMO ZERO of those trades should have been canceled. Trades are supposed to only be canceled where there was an UNINTENTIONAL error made. The typical case is "I meant to enter a price of 50.00 and I mistakenly entered a price of 5.00 or 500.00." The same error can occur on the size of the trade, i.e. 100,000 shares instead of 100 shares. In this case, NOT a SINGLE trade that went through has been shown to have been erroneously entered. Certainly the Waddell-Reed e-mini trades were NOT in error. They were entered exactly like Waddell-Reed intended.

3) The approach the SEC is pursuing is "we will try to make you whole after the "bad" trades occur." They will do this by canceling any trades they deem "bad." This is fundamentally different than saying "we will do whatever it takes WITHOUT limitation to PREVENT bad trades from occurring." This is why I said that investors should plan on continued flash crashes in the future. It will just be part of the investing landscape IMO.

4) Most people, specifically the 56 million non-METARites do not know that there have been about 10 mini single issue flash crashes since the original 5/6/10 flash crash. Last week, there were two separate mini-flash crashes. I posted about Progress Energy symbol PGN dropping 90% in 11 seconds. Yes, the “bad” trades were cancelled.

http://boards.fool.com/another-day-another-flash-crash-28788...

I did NOT post about LQD dropping 9% in three minutes last Friday. All of the “bad” trades were cancelled on that issue.

There have been several other cases where stocks traded at one cent, since the flash crash.

You don’t have to be a MENSA member to know that when you continue to see cases like these, then the system is marginally stable. How in Hades can you have a boring company like Progress Energy drop 90% and think the markets are functioning properly?


5) The SEC report does contain new rules for when stock trades will be cancelled. It is listed as footnote number 13 on page 7. I will not add it to this post, but you can look it up in the original report. Once again, the problem is that this deals after “bad” trades have occurred, as opposed to preventing them in the first place. Having well defined rules is certainly better than having nothing in writing, so I guess this is progress.


Thanks,

Yodaorange

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Author: Smufty2 Big red star, 1000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 340979 of 465361
Subject: Re: SEC lays an egg on Flash Crash Date: 10/3/2010 11:06 AM
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<I have to think that enterprising investors are hard at work figuring our how they will use these to increase profits at any available opportunity. . . >

Your suggestions?
Wendy


Couldn't hurt to leave some incredibly low-ball limit orders floating in the computers to fill on a flash crash; although, a lot of people have likely already done this...


Smufty

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Author: yodaorange Big red star, 1000 posts Feste Award Nominee! Feste Award Winner! Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 340981 of 465361
Subject: Re: SEC lays an egg on Flash Crash Date: 10/3/2010 11:24 AM
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Wendy,

1) Thanks for your kind words regarding the original post.

2) I should have been more blatant with the enterprising investors comment. What I meant to imply was that high frequency trading participants are actively working on ways to game the system for profits. I don't know of any strategies for small investors to game the system when flash crashes occur. Several HFT firms said they made record profits on the flash crash day. From a purely profits standpoint, they would like the see markets act like that more often.

3) The only strategy for small investors might be a fundamental based approach. Some argue that since the flash crash has apparently driven small investors out of the market, this is a contrarian buy signal.

4) The major point of contention in possible solutions to prevent future flash crashes revolves around one issue. Here are the two opposing sides:

a) High Frequency Traders provide a valuable service by providing additional liquidity and narrow the spreads. HFT does NOT alter the long term price/value of a security. Small investors are benefitted by their presence.

b) High Frequency Traders are a net detriment to small investors. They are extracting money from the system at the expense of small investors. Since they can withdraw from the market at will, they can and will cause more flash crashes in the future. They damage the small investor by convincing him the markets do not have rational pricing in the very short term, i.e. seconds, minutes, hours.

This is a highly polarizing issue, with strong opinions on both sides. My take is that as a practical matter, I don’t see any major changes in the current HFT approaches on the horizon.

Thanks,

Yodaorange

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Author: PosFCF Big gold star, 5000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 340983 of 465361
Subject: Re: SEC lays an egg on Flash Crash Date: 10/3/2010 11:33 AM
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I have to think that enterprising investors are hard at work figuring our how they will use these to increase profits at any available opportunity. . .

Therein lies the problem and the solution in Capitalism. The Capitalist will always try to find the way to game the system for profit and then exploit it to its fullest, which causes the imbalances which ultimately crash the Capitalistic system. But hope springs eternal and, from the ashes, will spring another system, this one designed to be absolutely foolproof. And it will be....until the ingenuity of the entrepreneur catches up and exceeds that of the designer.

A few benefit immensely, perhaps many benefit somewhat until the collapse which wipes out the many and some of the few.

The interests (and anger) of the many will then, for a short while, outweigh the power of the few and regulations will either be invented or (most likely) re-discovered and repackaged and then implemented. The fervor to protect the many actually accomplishes that end until the initial blush calms down and then the Capitalists will make inroads into the regulatory structure to try to gain an edge that they can lever into profitability.

My idea on how to "play" the current system to my advantage is based upon some assumptions:

1). I believe a crash will happen again, and perhaps several times with only brief intervening time periods.

2). Of the trades that get undone, it will be only the most outrageously priced trades that will be unwound.

3). That the market will (mostly) correct itself after each occurrence.

4). That I have the fortitude to weather any crash scenarios.

Given the above, I am considering placing limit buy orders at prices I determine to be good buys for the business model being purchased. I will make these orders GTC (Good Until Canceled).

This way, if the crash occurs, then I stand a chance of getting those buy orders executed at prices that would make me satisfied that I made a good purchase. The trick to not having the trade unwound is for me not to get too greedy in the limit price I establish.

Poz

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Author: OffshoreDriller Big funky green star, 20000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 340985 of 465361
Subject: Re: SEC lays an egg on Flash Crash Date: 10/3/2010 11:46 AM
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2) The SEC lays primary blame for the flash crash on Waddell-Reed placing orders to sell short 75,000 e-mini SP500 contracts. The contracts have a nominal value of $4.1 billion which is supposed to impress the naïve that it is a large number. In fact, on a typical day about 2 MILLION of these contracts change hands. So the 75,000 represent about 3.75% of average trading. Does anybody believe that an incremental change of 3.75% volume should crash the US equity markets? I don’t think so. Similar trades to this likely have been done hundreds of times before without causing a flash crash.

not to split hairs too much, but this actually is a large volume of futures to be executed simultaneously. You are using daily average figures, and this amount was sold in a minute, and in a time of slower volume in the afternoon. In fact, the afternoon doldrums are about the slowest time of the day for trading volume. They picked the worst possible time of day to sell this volume of futures. I don't think what they did was prudent - i hope it was an error, not that I feel that good about errors either.

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Author: WatchingTheHerd Big red star, 1000 posts Feste Award Nominee! Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 340993 of 465361
Subject: Re: SEC lays an egg on Flash Crash Date: 10/3/2010 12:55 PM
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You don’t have to be a MENSA member to know that when you continue to see cases like these, then the system is marginally stable. How in Hades can you have a boring company like Progress Energy drop 90% and think the markets are functioning properly?

==================

Excellent analysis on all of this, yodaorange.

The point above again made me think of a post from 9/30/2010 regarding the suspension of trading of Hewlett-Packard as the company announced the appointment of a new CEO. I know both the NASDAQ and NYSE have existing rules providing for the suspension of trading in advance of "material news" being announced for a traded stock.

I couldn't help but think, though...

Why?

In this "efficient" market, shouldn't most holders of HPQ already be aware they canned the prior CEO for various reasons loosely related to professional conduct and that a new CEO selection was imminent and that the CEO selection would obviously have a major impact on the future performance of the company since CEOs single-handedly deliver all shareholder value (smirk)? Should not those shareholders with concerns about the company's possible new direction and leadership have already used the collective wisdom of the market and everyone else's reactions to the original firing to stage their strategy for the inevitable announcement of a new CEO?

Prior to the announcement, Hewlett-Packard's market capitalization was around $95 billion. It had about 2.7 billion shares outstanding and averaged nearly 26 million shares traded daily. I think if you look up the terms "widely held" and "liquid" in Roget's Financial Thesaurus, those entries might say "see Hewlett-Packard."

So why does the market need to have trading on a widely held stock halted while the company prepares to put a spin on its new CEO selection while the "efficient" market is open and presumably best in a position to properly respond to the news in the way an open, honest market is supposed to? One story about the CEO selection and resulting stock price drop referred to the 3.09% drop in HPQ shares as "tanking". Since when is a 3.09% change in valuation considered tanking? If the firm's selection of a new CEO was truly viewed with such disdain to cause shareholders to flee to the exits, why should the firm be shielded by the exchange from the full immediate reaction to its selection of top management?

This really doesn't add up to signs of a healthy market. It adds up to signs of a market with unexplained, undocumented weaknesses and behind-the-scenes rules and mechanisms being operated for the benefit of the few rather than the many.


WTH

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Author: yodaorange Big red star, 1000 posts Feste Award Nominee! Feste Award Winner! Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 340996 of 465361
Subject: Re: SEC lays an egg on Flash Crash Date: 10/3/2010 1:34 PM
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Offshore Driller wrote: "not to split hairs too much, but this actually is a large volume of futures to be executed simultaneously."

Offshore, my apologies for not being clearer on this. Waddell-Reed did NOT try to sell all 75,000 e-mini contracts simultaneously. They used a sophisticated algorithmic computer program to space out the trades over a twenty minute period.

Karl Denninger devoted an entire post to showing that the Waddell-Reed volume was nothing out of the ordinary. For example, he shows that in the last one minute of trading on Friday that 71,573 contracts were traded and the market did not crash. So Waddell-Reed was attempting to do 1/20th the volume and the SEC alleges it crashed the market.

Link to Denninger tirade about the SEC report:
(Thanks to REITbird on the REIT board for passing along the link!)

http://market-ticker.org/akcs-www?singlepost=2194133


Thanks,

Yodaorange

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Author: SteadyAim Big red star, 1000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 341013 of 465361
Subject: Re: SEC lays an egg on Flash Crash Date: 10/3/2010 5:08 PM
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Offshore, my apologies for not being clearer on this. Waddell-Reed did NOT try to sell all 75,000 e-mini contracts simultaneously. They used a sophisticated algorithmic computer program to space out the trades over a twenty minute period.

I'm not sure whether the algorithm qualifies as "sophisticated", certainly it didn't just sell them in one hit, but it does seem that the parameters given were, at least with hindsight, not restrictive enough to prevent it moving the market. From reading some of the SEC report (still in progress, but actually quite impressed so far) it seems they specified a volume parameter (something like trades should be no more than 1/9 of volume traded) but no price restriction. The market was already heading down and then the program started selling. The HFT's took a lot of the sells but then increased their trading volume, in sum largely selling the futures back and forth to each other, hence the volume condition appeared to be met and the program continued making more sells. Since the so-called "sophisticated" algorithm wasn't even looking at the price, it didn't realise it was pushing the price down, and just carried on selling.

Karl Denninger devoted an entire post to showing that the Waddell-Reed volume was nothing out of the ordinary. For example, he shows that in the last one minute of trading on Friday that 71,573 contracts were traded and the market did not crash. So Waddell-Reed was attempting to do 1/20th the volume and the SEC alleges it crashed the market.

Link to Denninger tirade about the SEC report:


Tirade is the right word, but it's a pity I don't see any logic in there. Anyone can use aggressive language but it doesn't make them right. It seems obvious to me that closes are "special" and likely to behave differently to other times. More to the point he seems to assume that just because the market handled X amount of volume on occasion Y, it will always be able to handle that much volume. This seems obviously false to me, liquidity and depth clearly vary noticeably during every trading day never mind on different days. And there is clearly a difference between a relatively stable market where there is lots of depth on both sides, and a trending market where bids are being pulled and the sell volume clearly outweighs the buy volume.

I guess he's like Fox News, he has to shout loud to get customers, but I didn't believe a word of it. (I confess the rant tone wound me up, if someone else is saying the same thing in more measured terms, maybe I would give them more credence.)

On a day when the market has already fallen a few %, and at a relatively quiet time of day, it doesn't surprise me one bit that it failed to absorb that much volume from one side.

Another key point I have taken from the SEC document is that on the 3 other times that firm did a trade of this size (buying this lot back a few days later, and a sell and buy at another time) they spread the trades over 5 or 6 hours.

This seems similar to a "fat finger" trade to me - maybe the seller chose the program parameters deliberately, but they found out the hard way (I hope they lost money on this trade!) that their volume restriction was useless. I guess there's a reason they took around 15 times longer on the other times they did this.

On the plus side, its good to see that the SEC recognise that the prospect of trades being cancelled encourages traders to stop trading. They are trialling some new definitions of when trades will be cancelled so that traders can have some idea of whether their trades will be honoured.

SA

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Author: michaelservet Big red star, 1000 posts Feste Award Nominee! Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 341016 of 465361
Subject: Re: SEC lays an egg on Flash Crash Date: 10/3/2010 6:25 PM
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Barron's had an interesting update today on former NYSE specialist Jim Maguire and his long-running and lonely crusade to have trading conducted in 'nickle' rather than 'penny' increments. Following the shift to penny from '16ths' pricing a decade ago, Maguire had noted what he had perceived as shortcomings of the much-narrower-range penny increments.

Barron's had first covered Maguire's crusade in 2005. "Meet Mr. Nickel," April 25, 2005) http://online.barrons.com/article/SB111421958890914976.html

A couple of excerpts from that more lengthy 2005 article:

"Over the past four years, however, nearly everyone intimately involved with trading has become frustrated by the penny regime. While the apparent bid-ask spreads have narrowed, the amount of stock available at the quoted market prices has shriveled to insignificant levels....Because displaying a bid or offer is an invitation for another trader to step in front of the order for the price of a mere penny per share and get a trade off first, limit orders have become scarce....Virtually the only folks satisfied with the penny arrangement are programmers of so-called black boxes, statistically oriented trading systems... This type of activity....has risen to an average of 50% of exchange volume from 22% in late 2000.

"The idea behind Maguire's push is that setting somewhat wider price increments will give investors and speculators places to congregate with indications of buying and selling interest, making for more transparent, deeper and more liquid markets. As it now stands, a look at the bids and offers provides only a hint at the true supply and demand for a stock."

Maguire, now about 80 and associated with Barclay's, was the NYSE's long-time market maker for Berkshire Hathaway stock.

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Author: klee12 Big red star, 1000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 341021 of 465361
Subject: Re: SEC lays an egg on Flash Crash Date: 10/3/2010 8:05 PM
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Yoda, very good post as usual ...

<<Trading is best described as a marginally stable system. What we learned is that it is relatively easy to have the system go unstable and out of control.>>

Let me offer a suggestion why it is so unstable now. I will assume no one trader can move the market significantly with a single trade. I will assume a large number of hedge funds/traders can move the market if they act collectively. It seems that it is possible that a large number of hedge funds, acting independently and legally, employ a similar strategy and program their computers to sell long at a similar price. Then a relatively small perturbation from a stable trading range might cause a large move in the market. That large move might encourage other traders and ETF funds or whatever to sell and cause a panic.

Isn't that what happened in Oct of 1987 (?)

I haven't read the report but it might be that Waddell-Reed, acting legally, morally, and rationally, inadvertently started panic. Was the sale a market order?

One solution might be to limit the size of a market order to X percent of the last days trading volume. The Waddell-Reed might have had to sell in smaller chunks.

A circuit breaker might help also.

Are there unintended consequences to the two suggestions?

Comments, corrections, bricks welcome

klee12

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Author: klee12 Big red star, 1000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 341022 of 465361
Subject: Re: SEC lays an egg on Flash Crash Date: 10/3/2010 8:24 PM
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Ooops sorry I posted before I read the whole thread. It looks like maybe I'' have to think more about the causes of instability. Somehow, I don't think things like this happened in the stone ages (before computers and so many hedge funds using computers) so somehow I think computers are involved.

Sorry

klee12

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Author: PolymerMom Big gold star, 5000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 341024 of 465361
Subject: Re: SEC lays an egg on Flash Crash Date: 10/3/2010 8:56 PM
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klee12,

You are correct that no one trader can move the market that quickly with a single trade. However, if one considers how the trader chose to sell and the players involved, it could happen with increasing frequency.

As I understand what happened, the sell order was "serviced" by the HFT, who never hang on to anything for more than 5 minutes (or less). The sell order used an algorithm which resulted in positive feedback. Things went downhill from there.

http://www.econbrowser.com/archives/2010/10/causes_of_the_f....

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Author: PolymerMom Big gold star, 5000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 341025 of 465361
Subject: Re: SEC lays an egg on Flash Crash Date: 10/3/2010 8:58 PM
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Sorry, I didn't see your next post before posting. ANyway, folks on the board may benefit from seeing the EconBrowser post.

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Author: VUCommodore Big red star, 1000 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 341047 of 465361
Subject: Re: SEC lays an egg on Flash Crash Date: 10/4/2010 10:13 AM
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" The SEC totally, 100% missed the most important points to highlight to the masses. "

Prehaps this is because they, like you, anticipate that their report will only be read by METAR-ites and the like, not the masses?

"Does anybody believe that an incremental change of 3.75% volume should crash the US equity markets? I don’t think so. Similar trades to this likely have been done hundreds of times before without causing a flash crash...Waddell-Reed is basically a widows and orphans mutual fund manager that was trying to hedge an $81 billion equity position. So it is not like they were some wild eyed speculator using 100 to 1 leverage or doing naked shorting. What they were doing was 100% legal, 100% moral, 100% rational and probably prudent."

The way in which an order is executed can be the catalyst for a "flash crash", although I agree that it is an oversimplification to "blame" them... it is more of a perfect storm, chaos theory / butterfly effect situation, and I don't think that anybody is accusing Waddell-Reed of illegalities or immorality. Prudence would depend on the form of execution.


"Trading is best described as a marginally stable system. What we learned is that it is relatively easy to have the system go unstable and out of control. Think of a jet fighter flying 100 feet off the ground at Mach 1. If something goes wrong, you get a large earth crater in a few milliseconds. That is kind of what our markets have evolved to. Incredibly high speeds with not much margin for error."

I have a book recommendation for you based on the rationale you espouse here -- "Deep Survival" by Laurence Gonzalez. One of his key takeaways is that more complex systems are more likely to break down in unpredicted ways, despite their seeming safety etc. For example, climbing a glacier alone has obvious risks -- i.e. falling down the mountain. People attempt to protect themselves from that risk by tieing multiple climbers together, to catch any individual who falls. This, however, trades the obvious risk for several less obvious ones -- for example, a story on Mt Rainier where four climbers roped together still fell down a steep glacier, and the rope severely injured several other climbers who were further downhill. Fascinating stuff to me, and prehaps to you as well.

"If someone wanted to use lets call them questionable techniques to game the market, it is a lot more obvious how to do it after all of the flash crash research came out. I have to think that enterprising investors are hard at work figuring our how they will use these to increase profits at any available opportunity. . . "

Of course, the cancellation of tons of trades limits the upside from this, while the reputational downside remains. But market manipulation like this is as old as the markets themselves. Even the panics of the late 1800s were often started by wealthy INDIVIDUALS manipulating the nascent banking system to take liquidity (i.e. gold and greenbacks) out of the pre-Fed monetary system in order to crash the Wall St equity market. Morality has rarely been an effective deterrent.

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Author: RayKinsella Big red star, 1000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 341048 of 465361
Subject: Re: SEC lays an egg on Flash Crash Date: 10/4/2010 10:21 AM
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As a practical matter, I don’t know how to put the genie of “stable” markets back into the bottle. While it is theoretically possible to do, there is so much money involved, I can’t imagine rolling back the clock. Stated differently: “Dorothy, we are NOT in Kansas anymore. Tapping your ruby red slippers together three times will NOT take us back to the stable markets of Kansas.”

Ironically, Waddell-Reed is Headquartered in Kansas.
Ray

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