SEC speculates on a 'flash crash'

With respect to the abrupt crash from a few weeks ago, well, it looks like the SEC is speculating on a "flash crash." I keep posting about this story because it is an important one. The fact that the stock exchanges rolled back trades, which is extremely unusual and very anti-capitalist, lends credence to the importance of this story. The Globe & Mail reports the following:

A preliminary investigation suggests a “severe temporary liquidity failure” was at the root of the incident, Ms. Schapiro said. The SEC has already ruled out a “fat finger” typing error, hackers or terrorists


What is clear is that the incident exposed serious flaws in today’s fast-paced computer-driven markets, where billions of simultaneous trades are clocked in nanoseconds. The result is that the market moves faster than the human brain can process, let alone stop.

The problem, regulators acknowledge, is that algorithms can be, well, stupid.

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Mr. Gensler singled out an unnamed trader, who “sought to hedge its stock portfolio in the futures markets by selling a predetermined amount of futures through an executing broker's automated execution system."

News reports have identified the company as money manager Waddell & Reed Financial Inc.

The SEC and major exchanges have already proposed a rule to suspend stock trading when markets swing violently. The new “circuit breakers” would apply to all stocks in the Standard & Poor's 500 index under a six-month trial rollout planned for June.

Some Senators also complained about the arbitrary way that exchanges later cancelled trades made in the midst of the market mayhem.

“It's hard for me as someone who worked in the market for 31 years to understand how any trades can be broken arbitrarily by an exchange,” said Kentucky Senator Jim Bunning, a former professional baseball player and broker. “Those are arbitrary rules and for someone who was left out of those arbitrary rules, in other words, didn't fit in the box, how do you think they feel?”

Regulators have been sifting through more than 19 billion trades as they piece together what happened May 6. They’re also looking at links between automatic “stop-loss” orders and sudden declines in prices of stock index products such as E-mini S&P futures contracts.

The legality of the actions taken by the exchanges (to roll back select trades) is still not clear to me. Trading seems prone to manipulation if exchanges were allowed to cancel whatever trades they wanted, without giving any reason. Hopefully the SEC will get to the bottom of this. It could take another year or two but I'm hopeful that they will at least identify the cause.