What Is a Flash Crash?

In this post “What Is a Flash Crash?”, you’d learn about flash crash. This includes: examples of flash crashes, flash crashes in the past, causes of flash crash, NASDAQ flash crash in 2013 and other years.

A flash crash is a market scenario in which the price of an item drops dramatically in a short period of time.

What Is a Flash Crash and How Does It Happen?

A market scenario in which the price of an asset drops dramatically in a short period of time, then quickly recovers to former levels is known as Flash Crash. A fast collapse in the bitcoin market may happen in minutes or even seconds. In the crypto market, high-frequency trading is one of the major drivers of such disasters.

The high negative price volatility of digital currency is unavoidable  . As a consequence of the intense selling forces, crypto values see quick swings, resulting in flash collapses in several situations.

Other sectors, such as shares and exchange rates, also have flash crashes.

 The July 2015 flash, when an effect on the New York Stock Exchange (NYSE) stopped trading for nearly three hours, was one of the most noteworthy stock market hits.

Other instances include the 2014 bond flash crash, which was triggered by algorithm-driven trading programs, and the 2010 Dow collapse, which was triggered by spoofing.

Flash crashes are triggered in various ways depending on the cryptographic environment. In 2021, for example, Bitcoin witnessed a flash collapse, wiping out around $310 billion from the digital currency market and causing $10 billion in BTC liquidations.

The meltdown happened as a consequence of blackouts in China’s Xinjiang area, which is home to some of the world’s biggest Bitcoin mining facilities. Power outages in various cities caused over half of Bitcoin’s network to fall down, dropping from 215 to 120 exahash per second, causing a large pullback, according to further analysis.

More Information About Flash Crash

The phrase “flash crash” describes a situation in which stock withdrawal orders swiftly exacerbate price falls before fast rebounding. A flash crash seems to be characterized by a quick sell-off of assets that may occur in a matter of minutes, leading in spectacular price drops. However, prices had returned to normal by the end of the day, as if the flash collapse never occurred.

Points to Note:

  • A flash crash occurs when a marketplace or a stock’s price drops rapidly due to a retraction of orders, accompanied by a swift recovery during the same trading day.
  • High-frequency trading companies are blamed for the majority of contemporary flash crashes.
  • To avoid flash crashes, governing bodies in the United States have taken swift action, such as placing circuit breakers and prohibiting direct access to exchanges.
  • On May 6, 2010, a flash collapse wiped out billions of dollars in equities, resulting in the largest decline in DJIA history.
  • On any given day, there are around 12 small flash crashes, per some assessments.

What Causes a Flash Crash?

As previously stated, flash crashes occur when the price of a security drops dramatically and then swiftly recovers—all inside the same day. By the conclusion of the trading day, it nearly looks as if the collapse never occurred.

  1. This was the situation on May 6, 2010, when the stock market in the United States saw a sharp decline before recovering by the close of the day.
  2. Market anomalies, such as significant selling by high-frequency investors in one or more assets, worsen flash collapses.

As a result, computer trading systems respond instantaneously to these circumstances by selling enormous amounts of securities at a breakneck speed in order to avert losses.

Circuit breakers at large stock exchanges, such as the New York Stock Exchange (NYSE), may be triggered by flash crashes, which stop trading until buy and sell orders are equally balanced and trade can restart in a timely manner.

As trade gets increasingly digital, technology tools, instead of a single piece of market or corporate news, are more often used to generate flash crashes. As the price drops and additional criteria are activated, a domino effect might occur, resulting in a sharp decline in value. However, much more study on flash crashes is required, including any indications of unethical activities.

Whilst high-frequency traders’ activity is clearly related to flash crashes (and is typically a major component), it’s crucial to remember that there may be a slew of other contributing variables, many of which are difficult to define.

Preventing a Flash Crash from Happening

Now that stocks trading is a fully automated sector controlled by complex algorithms over worldwide networks, the likelihood of malfunctions, mistakes, and flash crashes is significantly greater. Global exchanges such as the New York Stock Exchange (NYSE), Nasdaq, and the Chicago Mercantile Exchange (CME) have superior security procedures and systems in place to avoid them and the massive losses they may cause.

They have, for instance, installed market-wide circuit breakers that cause trade to halt or stop completely. Market activity is halted for 15 minutes if a market’s index falls by 7% or 13% from its prior closing. Trading is halted for the remainder of the day due to a 20% drop.

The Securities and Exchange Commission (SEC) also outlawed “naked access” to exchanges and “direct connections.” High-frequency trading businesses, which have been criticized for hastening the impacts of the flash collapse, often leverage their broker-code dealer’s to get direct access to exchanges. Although such procedures cannot completely eradicate flash crashes, they have been shown to reduce the harm they may do.

Illustrations of Flash Crash

On May 6, 2010, one of the most well-known instances of a flash crash in modern years happened. The Dow Jones Industrial Average (DJIA) plunged more than 1,000 points in 10 minutes soon after 2:30 p.m., the largest decline in records at the time. Within an hour, the index had lost about 9% of its value. Over $1 trillion in equity was lost, yet the stock market recovered 70% by the end of the day.

According to initial accounts, the incident was triggered by a mistyped command that turned out to be incorrect. Navinder Singh Sarao, a futures trader from the London suburbs, pleaded guilty to trying to spoof the market by rapidly purchasing and selling hundreds of E-Mini S&P Futures contracts via the CME.

Other Types of Flash Crashes

Other earlier occurrences mimicking flash crashes occurred when the amount of computer-generated orders outstripped the exchanges’ capacity to ensure normal order flow. These are some of them:

  • Trading at the Nasdaq was paused for over three hours on August 22, 2013, when the NYSE’s systems were unable to process price information from the Nasdaq. 
  • May 18, 2012: While not a flash collapse, Meta (previously Facebook) shares were propped up for more than 30 minutes at the opening bell due to a Nasdaq error that hindered the company from appropriately pricing its shares during its initial public offering (IPO), resulting in an estimated $500 million deficit.

What Caused the 2010 Flash Crash?

The Flash Crash of 2010 was allegedly sparked by a single order selling a significant number of E-Mini S&P futures, according to an SEC investigation report.

Is it Possible for a Flash Crash to Occur Again?

Even though exchanges have put in place safeguards to deter them from happening, flash crashes may and do occur. The stock market produces around 12 tiny flash crashes every day, as per two math professors at the University of Michigan in Ann Arbor.

What Does a Stock Market Flash Crash Mean?

A stock market flash crash is defined as a quick drop in the price of a stock or an entire market as a result of the withdrawal of orders. Markets then bounce back to about where they were before to the fall, almost as if it never happened.

Duration of a Flash Crash

A flash crash occurs in the middle of a trading day and may last anywhere between a few minutes to many hours.

Causes of Flash Crash

A flash crash is frequently caused by a massive block of transactions. Any crash is exacerbated by computer trading systems. These “bots” use algorithms to detect anomalies, such as sell orders. To prevent future losses, they immediately liquidate their shares.

When a major crisis or a computer error alerts them to anything unexpected, these programs immediately sell based on their most recent code. Any stock movement becomes more extreme as a result of these trading systems, increasing risk. 

One of these collapses, it is feared, might trigger a recession. A typical stock market collapse indicates a drop in economic confidence. A recession occurs when trust is not restored. Typically, investors recognize that a flash collapse is triggered by a technical problem rather than a lack of trust.

A flash crash, on the other hand, may lead to a loss of credibility if it persisted long enough to raise fear. It would also devastate investor wealth. If it lasted long enough, it may even scare customers into purchasing less. It might be just enough to send the economy into a tailspin at the wrong time.

Mini flash crashes, which are sudden declines in the price of particular stocks or futures, happen all the time.

Flash Crashes in the Past

Throughout the millenium, there have been many flash crashes.

Flash Crash on the New York Stock Exchange in 2015

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 consequence, the NYSE lost 40% of its trade volume.

The reason for the outage is currently unclear. 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.

Bond Flash Crash of 2014

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 exploded all of a sudden. When bond prices rise, bond yields fall. It was the greatest drop in a single day since 2009. The volume was twice as high as usual.

Some people accuse algorithm-based trading algorithms for the majority of trading in the US Treasury, which is estimated to be 50% in cash securities and 60% to 70% in futures. The bank’s participation and over-the-phone orders have decreased as electronic trading has grown. Any market response may be sped up by combining automation and high frequency trading.

There was also a scarcity of accessible bonds to sell. Despite the fact that 10-year note activity was rising, market depth was shockingly low.

The Dow Jones Industrial Average Crash of 2010

On May 6, 2010, the Dow dropped 1,000 points in ten minutes. It was the largest point decline in history, losing $1 trillion in stock market value.

Navinder Sarao, a London suburbanite, was using a pc at his house at the time. Prosecutors discovered Sarao had created and promptly terminated hundreds of “E-mini S&P” futures contracts five years later, in 2015. He used a technique known as “spoofing,” which is unlawful.

As a consequence, Waddell & Reed depleted futures contract liquidity by dumping $4.1 billion worth of contracts.

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

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

At the time, everyone assumed the meltdown was triggered by the Greek financial crisis. 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) allows Greece to default, it might lead to defaults in other debt-ridden nations such as Portugal, Ireland, and Spain. Investors who bought these nations’ bonds would have lost a lot of money.

The London Inter-Bank Offered Rate (LIBOR) climbed as a result of the influx of banks.

This occurred in a similar way to the bank credit crisis of 2007.

Fears of a credit freeze in European banks arose as a result.

It did not, like many other previous collapses, result in a recession.

NASDAQ Flash Crash in 2013 and Other Years

The NASDAQ is known for its frequent flash collapses. 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 was unable to interface with a NASDAQ server that provided stock price information.

The issue could not be fixed after repeated tries, and NASDAQ’s stressed server fell down.

When the Facebook (now Meta) first public stock offering was issued, NASDAQ computer problems cost traders $500 million. On May 18, 2012, the IPO was delayed for 30 minutes. Traders were unable to make, modify, or withdraw orders. When the issue was fixed, a record 565 million shares were exchanged.

Is it possible that the stock market is rigged?

The advent of these high frequency trading systems, according to Michael Lewis, author of Flash Boys, implies that an average investor cannot get ahead. The algorithms process enormous volumes of data and make split-second choices and transactions much faster than a person could. Companies like Goldman Sachs and JP Morgan, who utilize them, haven’t lost a deal in years. According to Lewis, the stock market is rigged against the typical investor.

Lewis appeared on CNBC to justify his study to the CEO of BATS, the second biggest exchange after the NYSE. It’s a bigger version of the NASDAQ, which is an all-electronic market.

How Does It Affect You?

So far as you’re involved, if Wall Street isn’t rigged, it may as well be. An human stock picker will never be able to acquire more data than these computer trading systems.

This is why so many asset types are moving in lockstep. These programs are also unregulated.

The position, however, is not bleak. On a daily level, it’s hard to outthink these systems, but the economic cycle may help you predict where the market is heading. Maintain a well-balanced portfolio. To achieve a respectable return, modify your asset allocation every quarter. It’s important to remember that it’s not how much you earn that matters, but how little you risk.

What causes flash crashes in the first place?

Flash crashes, as previously said, happen quite rapidly. It is apparent that the price decline and comeback are not due to the revelation of negative news followed by positive news. Another thing to keep in mind is that the fall might affect a whole stock index rather than just one stock, bond, or commodity.

The reason for the fall is typically not related to a perceived change in the stock’s fundamental worth.

Software programs or procedures are one source of flash crashes.

Trading using algorithms is becoming more popular. Computers can process massive volumes of data and execute big-volume transactions in a fraction of a second, far exceeding human decision-making skills. Selling pressures are incorporated into certain algorithms. When there are more sells than buys, for instance, the algorithms begin to sell as well.

This has a snowball effect, and due to the speed with which computers execute transactions, the market plummets.

Another element that is thought to have triggered or exacerbated flash crashes is high-frequency trading. These dealers utilize technologies to complete massive trades quickly. Traders may also employ algorithms to engage in illicit activities like spoofing. Algorithms are trained to place phony sales in spoofing. For instance, the dealers may place an order for 400 sales but then cancel it before it is fulfilled. Prices are pushed down by simply placing such a massive sell order, and traders will subsequently purchase at the lower price. This procedure has grown very successful thanks to algorithms, and it is now banned. This is only one example of how algorithms may cause market volatility.

More investigation is required.

According to studies into past flash crashes, there are still a number of unanswered questions about why these disasters occur. While high frequency trading through the use of analysis tools are thought to have a role in driving markets up or down and fostering herd behavior, other variables are also thought to be at play. It’s also often impossible to establish if persons or corporations may benefit from intentionally causing flash crashes.

Examples of Flash crashes

The occurrence of flash crashes is rather common. The majority, though, are insignificant and do not make the headlines. The 2010 Flash Crash was the first noteworthy flash crash.

The Dow Jones index lost over 9% of its value and roughly $1 trillion in equity in a short period of time during this catastrophe. However, by the conclusion of the trading day, the index had recovered 70% of its losses.

For various reasons, this flash collapse was very noteworthy. For starters, it was significant because of the enormous drop in value, and it was widely covered by the media. Second, it raised awareness of the significance of computer algorithms in causing market volatility and uncertainty.

Yen and Australian dollar in 2019

The Yen’s relative value against the Australian dollar accelerated by 7% in the first quarter of 2019. The surge occurred in a matter of minutes, with no warning. This might have happened for a number of reasons, including a lack of liquidity and concerns about a worldwide recession. One aspect was Apple’s announcement on the morning of the fall that its earnings were down owing to a recession in China. This  information prompted dealers to invest the yen, a safe-haven currency.

Here is a list of more related topics you might find interesting:
  1. Blockchain Technology
  2. Defi
  3. NFTs
  4. DAOs
  5. Crypto
  6. Web 3.0
  7. Altcoin Tokenomics
  8. Metaverse
  9. Smart Contracts

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