Flash Crashes

A situation in which stock withdrawal orders rapidly exacerbate price falls before quickly rebounding.

Author: Elliot Meade
Elliot Meade
Elliot Meade
Private Equity | Investment Banking

Elliot currently works as a Private Equity Associate at Greenridge Investment Partners, a middle market fund based in Austin, TX. He was previously an Analyst in Piper Jaffray's Leveraged Finance group, working across all industry verticals on LBOs, acquisition financings, refinancings, and recapitalizations. Prior to Piper Jaffray, he spent 2 years at Citi in the Leveraged Finance Credit Portfolio group focused on origination and ongoing credit monitoring of outstanding loans and was also a member of the Columbia recruiting committee for the Investment Banking Division for incoming summer and full-time analysts.

Elliot has a Bachelor of Arts in Business Management from Columbia University.

Reviewed By: Himanshu Singh
Himanshu Singh
Himanshu Singh
Investment Banking | Private Equity

Prior to joining UBS as an Investment Banker, Himanshu worked as an Investment Associate for Exin Capital Partners Limited, participating in all aspects of the investment process, including identifying new investment opportunities, detailed due diligence, financial modeling & LBO valuation and presenting investment recommendations internally.

Himanshu holds an MBA in Finance from the Indian Institute of Management and a Bachelor of Engineering from Netaji Subhas Institute of Technology.

Last Updated:December 12, 2023

What are Flash Crashes?

The phrase "flash crash" refers to a situation in which stock withdrawal orders rapidly exacerbate price falls before quickly rebounding. 

A flash crash is characterized by a quick sell-off of assets that can occur in minutes, resulting in spectacular price drops. However, prices return to normal by the end of the day, as if the flash crash never happened.

What causes flash crashes?

As previously stated, they occur when a security's price drops dramatically and swiftly recovers—all within the same day. By the conclusion of the trading day, it nearly looks as if the crash never happened.

Anomalies in the market, such as solid selling by high-frequency traders in one or more assets, aggravate these large movements. As a result, computer trading systems respond automatically to this considerable bullish pressure by selling enormous amounts of securities at a breakneck speed to avert losses.

Circuit breakers at large stock exchanges, such as the New York Stock Exchange (NYSE), can be triggered by flash crashes. These halt trading until buy and sell orders are evenly balanced, and trade can restart promptly.

Computer algorithms, rather than a single piece of market or corporate news, are more commonly the source of flash crashes as trade becomes digitized. 

As the price drops and additional robot traders are activated, a domino effect can occur, resulting in a sharp decline in value. However, more research on these events is required, including how frequently they are related to fraudulent behavior.

Preventing a Flash Crash

Since stock trading is a fully automated sector controlled by complex algorithms over worldwide networks, the likelihood of malfunctions, mistakes, and flash crashes is substantially higher. 

Global exchanges such as the New York Stock Exchange (NYSE), Nasdaq, and the Chicago Mercantile Exchange (CME) have superior security procedures and systems to avoid flash crashes and the massive losses they may cause.

These exchanges have, for example, installed market-wide circuit breakers that cause trade to pause or stop altogether. 

Trading activity is halted for 15 minutes if a market's index falls by 7% from its previous closing. It is activated again if it drops 13%, while trading is halted for the remainder of the day if there is a 20% drop.

The Securities and Exchange Commission (SEC) also outlawed "naked access" to exchanges.

High-frequency trading businesses, which have been criticized for hastening the impacts of flash collapses, frequently leverage their broker-code dealers to get direct access to exchanges. Although such procedures cannot completely eradicate this, they have been shown to reduce the harm these firms can do.

Examples of flash crashes

The following are some of the most famous flash crashes in history. While their effects and causes vary, they all share one thing in common: a sharp drop followed by a quick recovery.

1. 2015 NYSE

On July 8, 2015, the New York Stock Exchange (NYSE) suspended trade for three hours and 38 minutes. The NASDAQ, BATS, and several "black pools" were swiftly relocated to the 11 other exchanges. As a result, the NYSE lost 40% of its trade volume. 

The reason for the outage is currently unknown. It might have been related to the suspension of United Airlines flights or the closing of the Wall Street Journal's site. They both happened on the same day.

2. 2014 Bond

On Oct. 15, 2014, the yield on the 10-year Treasury note fell from 2.02 percent to 1.86 percent in a matter of minutes. It instantly bounced back. 

The drop gave the impression that demand for these notes had suddenly exploded. When bond prices rise, bond yields fall. It was the most significant drop in a single day since 2009. Nevertheless, the volume was twice as high as usual.

Many people blame algorithm-based trading robots for the majority of trading in U.S. Treasury bills. It is estimated that these programs make up 50% of the volume in cash securities and 60% to 70% in futures. 

The bank's involvement and over-the-phone orders have decreased as electronic trading has grown. Any market reaction may be sped up by combining automation and high-frequency trading.

There was also a scarcity of accessible bonds to sell. As a result, even though the 10-year note volume was rising, market depth was shockingly low.

3. 2010 Dow

On May 6, 2010, the Dow dropped 1,000 points in ten minutes. It was the most significant decline in history, losing $1 trillion.

Navinder Sarao, a London suburbanite, was using a personal computer at his house at the time. Five years later, in 2015, investigators discovered Sarao had made and promptly canceled hundreds of "E-mini S&P" futures contracts. 

He used a technique known as "spoofing," which is illegal. As a result, Waddell & Reed depleted futures contract liquidity by dumping $4.1 billion worth of contracts.

Sarao and his broker, MF Global, informed the CME Group that his trades were meant to be conducted in good faith.

Spoofing is a method of manipulating market prices by inflating them fraudulently and then swiftly selling them for a profit.

At the time, everyone assumed the Greek financial crisis triggered the meltdown. Rating agencies had just lowered the county's debt to junk bond status. Protests erupted in the streets as a result of this. 

If the European Central Bank (ECB) allowed Greece to default, it might lead to defaults in other debt-ridden nations such as Portugal, Ireland, and Spain. As a result, investors who bought these nations' bonds would have lost a lot of money.

4. 2013 and Other NASDAQ 

The NASDAQ is known for its frequent flash collapses. For example, on August 22, 2013, it was closed from 12:14 p.m. until 3:25 p.m. EDT. 

One of the NYSE's computer systems could not interface with a NASDAQ server that provided stock price information. The problem could not be fixed despite repeated tries, and NASDAQ's stressed server fell. 

When Facebook's (now Meta) initial public offering (IPO) was announced, NASDAQ computer faults cost traders $500 million. 

On May 18, 2012, the IPO was delayed for 30 minutes. Traders were unable to place, modify, or cancel orders. When the issue was fixed, a record 565 million shares were exchanged.

Flash Crashes FAQs

Researched and authored by Tanay Gehi | LinkedIn

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