May 6th Flash Crash explained

A Single Sale Worth $4.1 Billion Led to the ‘Flash Crash’


Excerpts:

A single sale of $4.1 billion in futures contracts by a mutual fund touched off a series of events that led to the so-called flash crash, the sharp stock market decline that shook investors and markets on May 6, federal regulators said on Friday.

In a long-awaited report, the Securities and Exchange Commission and the Commodity Futures Trading Commission said they had identified the sequence of events that erased more than 600 points from the Dow Jones industrial average in minutes on the afternoon of May 6 before the markets recovered just as quickly.

Significantly, the report found that the plunge was not caused by any market manipulation but by a single firm trying to hedge its investment position, if in an aggressive and abrupt manner.

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It said that at about 2:32 p.m., a mutual fund — which was not identified in the report, but which officials have identified as Waddell & Reed Financial of Kansas — started a program to sell 75,000 E-Mini Standard & Poor’s 500 futures contracts, using computer sell algorithms. Normally, a sale of this size would take place over as many as five hours, but the large sale was executed in 20 minutes, the regulators said.

The algorithm was programmed to execute the trade “without regard to price or time,” the report said.

The selling pressure was then transferred from the futures markets to the stock market, leading to the abrupt drop in individual stocks.

Stock and stock-index futures prices were already declining on May 6 when, about 2:42 p.m., they suddenly plunged by more than 5 percent over the next five minutes.

When prices bottomed at about 2:47 p.m., the Dow Jones industrial average was down nearly 990 points, 9.1 percent below where it had started the day. Almost as quickly as prices dropped, however, they rebounded, with the Dow industrials recovering 543 points in about 90 seconds. The Dow finished the day down 347.80, or 3.2 percent, at 10,520.32.

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