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Was the Flash Crash Apple's Fault?


Apple was the number-one top broken stock by trading volume during the crash, but to appreciate this, one must reflect on market capitalization.

Editor's Note: This is Part 1 in a multi-part series. For Part 2, click here.

I'm fascinated by the rapid decline and complete recovery that took place in less than 15 minutes exactly one month ago today on May 6, 2010 coined the "flash crash." Even with the gloomy global economic backdrop since then, it's taken the S&P 500 a full month to close lower than the downward spike of that event which originally occurred in two to three minutes. In over 10 years of studying the markets on a daily basis, I've never seen anything like it. I've spent the last few weeks studying the "flash crash" for evidence that could lead to an explanation of how it happened.

I started my research after reading the Preliminary Findings Regarding the Events of May 6, 2010 by the SEC-CFTC Joint Regulatory Committee. The report is 80 pages long with another 100 pages of appendices. The report includes excellent research and is chock full of interesting facts and clues about the "flash crash." The report clearly states that it's preliminary, but I was still surprised by clues I thought were important that jumped off the page, but weren't highlighted or included as a focus for further study by the committee.

I wrote a letter to the committee highlighting one such clue I found in the report regarding the tight grouping of profits at the extreme pivot away from the start of the crash. In other words, a relatively small number of traders successfully sold short, then caught a falling knife at exactly the right time for some outlandish profits (almost a half billion). Even if the profits were subsequently denied because of canceled trades, the uncanny prescience of a select few to cover at the perfect time warrants further study, especially since what precipitated the crash is unknown.

One idea highlighted in the report that received popular media attention was that aggressive hedging precipitated the crash. Circumstantial evidence included one S&P 500 futures hedger who represented 9% of futures volume during the crash and the outsized number of ETFs among broken securities (69%) as a result of the crash. Futures and ETFs are considered primary vehicles for hedging.

The SEC-CFTC committee pointed out several inconsistencies with this thesis but highlighted that additional analysis of large futures traders and the outsized impact on ETFs were areas for further study. They also highlighted the role played by liquidity providers, high frequency traders, dark pools, and market mechanisms like circuit breakers, stop logic (forced pause CME Futures), stub quotes, stop-loss market orders, self-help (time-out mechanism allowing exchanges to stop routing orders), and liquidity replenishment points (forced pause NYSE), as areas for further study.

The report concluded that a confluence of economic events, market forces, and trading-system functionality led to a significant dislocation of liquidity as measured by broken trades, bid/offer spreads, self-help declarations, and outsized ETF factors.

Furthermore, due to the complexity and extremely tight linkage between the various market products, a detailed market reconstruction of hundreds of millions records, from dozens of different sources, comprising five to 10 terabytes of data, consuming a significant amount of staff resources, was required to sequence the events of the flash crash.
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