Tag Archives: S&P 500

Here's The Official Flash Crash Report; Scapegoat Found

“In summary, our analysis of trades broken on May 6 reveals they were concentrated primarily among a few market participants. A significant number of those trades were driven by sell orders from retail customers sent to internalizers for immediate execution at then-current market prices,” the US Commodity Futures Trading Commission and the US Securities and Exchange Commission concludes in their just released report on the so-called “flash crash” on May 6th this year. And they seem to have found a scapegoat:

“At 2:32 p.m., against this backdrop of unusually high volatility and thinning liquidity, a large fundamental trader initiated a sell program to sell a total of 75,000 E-Mini contracts (valued at approximately $4.1 billion) as a hedge to an existing equity position.”

US Commodity Futures Trading Commission – US Securities and Exchange Commission


“This large fundamental trader chose to execute this sell program via an automated execution algorithm (“Sell Algorithm”) that was programmed to feed orders into the June 2010 E-Mini market to target an execution rate set to 9% of the trading volume calculated over the previous minute, but without regard to price or time. The execution of this sell program resulted in the largest net change in daily position of any trader in the E-Mini since the beginning of the year,” the report says.

The “large fundamental trader” have been identified as the 73 years old investment firm Waddell & Reed.

“Only two single-day sell programs of equal or larger size – one of which was by the same large fundamental trader – were executed in the E-Mini in the 12 months prior to May 6. When executing the previous sell program, this large fundamental trader utilized a combination of manual trading entered over the course of a day and several automated execution algorithms which took into account price, time, and volume. On that occasion it took more than 5 hours for this large trader to execute the first 75,000 contracts of a large sell program,” SEC and CFTC notes.

Adding: “However, on May 6, when markets were already under stress, the Sell Algorithm chosen by the large trader to only target trading volume, and neither price nor time, executed the sell program extremely rapidly in just 20 minutes. “


Sell Pressure

According to the report, the sell pressure was initially absorbed by:

1. High frequency traders (“HFTs”) and other intermediaries8 in the futures market;

2. Fundamental buyers in the futures market; and

3. Cross-market arbitrageurs9 who transferred this sell pressure to the equities markets by opportunistically buying E-Mini contracts and simultaneously selling products like SPY, or selling individual equities in the S&P 500 Index.

“HFTs and intermediaries were the likely buyers of the initial batch of orders submitted by the Sell Algorithm, and, as a result, these buyers built up temporary long positions. Specifically, HFTs accumulated a net long position of about 3,300 contracts. However, between 2:41 p.m. and 2:44 p.m., HFTs aggressively sold about 2,000 E-Mini contracts in order to reduce their temporary long positions. At the same time, HFTs traded nearly 140,000 E-Mini contracts or over 33% of the total trading volume. This is consistent with the HFTs’ typical practice of trading a very large number of contracts, but not accumulating an aggregate inventory beyond three to four thousand contracts in either direction.”

“The Sell Algorithm used by the large trader responded to the increased volume by increasing the rate at which it was feeding the orders into the market, even though orders that it already sent to the market were arguably not yet fully absorbed by fundamental buyers or cross-market arbitrageurs. In fact, especially in times of significant volatility, high trading volume is not necessarily a reliable indicator of market liquidity.”

What happened next is best described in terms of two liquidity crises, the report says.

A Double Squeeze

“The combined selling pressure from the Sell Algorithm, HFTs and other traders drove the price of the E-Mini down approximately 3% in just four minutes from the beginning of 2:41 p.m. through the end of 2:44 p.m. During this same time cross-market arbitrageurs who did buy the E-Mini, simultaneously sold equivalent amounts in the equities markets, driving the price of SPY also down approximately 3%,” the regulators write.

“Still lacking sufficient demand from fundamental buyers or cross-market arbitrageurs, HFTs began to quickly buy and then resell contracts to each other – generating a “hot-potato” volume effect as the same positions were rapidly passed back and forth. Between 2:45:13 and 2:45:27, HFTs traded over 27,000 contracts, which accounted for about 49 percent of the total trading volume, while buying only about 200 additional contracts net.”

At this time, buy-side market depth in the E-Mini fell to about $58 million, less than 1% of its depth from that morning’s level. As liquidity vanished, the price of the E-Mini dropped by an additional 1.7% in just these 15 seconds, to reach its intraday low of 1056.

“This sudden decline in both price and liquidity may be symptomatic of the notion that prices were moving so fast, fundamental buyers and cross-market arbitrageurs were either unable or unwilling to supply enough buy-side liquidity,” the report explains.

In the four-and-one-half minutes from 2:41 p.m. through 2:45:27 p.m., prices of the E-Mini had fallen by more than 5% and prices of SPY suffered a decline of over 6%.

“The second liquidity crisis occurred in the equities markets at about 2:45 p.m. Based on interviews with a variety of large market participants, automated trading systems used by many liquidity providers temporarily paused in reaction to the sudden price declines observed during the first liquidity crisis. These built-in pauses are designed to prevent automated systems from trading when prices move beyond pre-defined thresholds in order to allow traders and risk managers to fully assess market conditions before trading is resumed,” the report says.

A Flash Back

Okay, before I continue, let’s relive the historical – and totally crazy – 20 minutes on the afternoon of May 6th. (Cut down to 10) as the old saying that “pictures are best on radio” once again proves its infinity:

A Triple Dose

According to the US regulators, there’s also three important lessons to be learned from the May 6th event.

#1. “One key lesson is that under stressed market conditions, the automated execution of a large sell order can trigger extreme price movements, especially if the automated execution algorithm does not take prices into account. Moreover, the interaction between automated execution programs and algorithmic trading strategies can quickly erode liquidity and result in disorderly markets. As the events of May 6 demonstrate, especially in times of significant volatility, high trading volume is not necessarily a reliable indicator of market liquidity.”

#2. “May 6 was also an important reminder of the inter-connectedness of our derivatives and securities markets, particularly with respect to index products. The nature of the cross-market trading activity described above was confirmed by extensive interviews with market participants (discussed more fully herein), many of whom are active in both the futures and cash markets in the ordinary course, particularly with respect to “price discovery” products such as the E-Mini and SPY.”

#3. “Another key lesson from May 6 is that many market participants employ their own versions of a trading pause – either generally or in particular products – based on different combinations of market signals. While the withdrawal of a single participant may not significantly impact the entire market, a liquidity crisis can develop if many market participants withdraw at the same time. This, in turn, can lead to the breakdown of a fair and orderly price-discovery process, and in the extreme case trades can be executed at stub-quotes used by market makers to fulfill their continuous two-sided quoting obligations.”

Withdrawal Symptoms

The regulators have conducted a series of interviews with market participants involved in the May 6th flash crash.

According to the interviews, almost everyone says they use a combination of automated algorithms and human traders to oversee their operations.

As such, data integrity was cited by the firms we interviewed as their number one concern, the report points out.

“To protect against trading on erroneous data, firms implement automated stops that are triggered when the data received appears questionable.”

“One way of identifying potentially erroneous data is to screen for large, rapid price moves. For example, it was reported that the rapid decline in prices of the E-Mini, starting around 2:40 p.m. triggered data-integrity pauses in trading across a number of automated algorithms. Rapid declines in individual securities also contributed to data-integrity concerns and triggered trading pauses. Collectively we refer to these as “price-driven integrity pauses.”

“It is important to note these types of pauses are not necessarily the result of erroneous price data, but instead are based on prudential checks into the possibility that large, observed price changes are the by-product of a system error. In fact, the large price declines simultaneously observed across securities and the E-Mini contract during the afternoon of May 6 were indeed real.”

Very High – Very Low

The high frequency trading have been suspected as a possible cause of the flash crash.

However, the SEC/CFCT report can’t confirm or dismiss the accusations.

“Of the HFTs we interviewed, we did not find uniformity in response to market conditions on May 6. Although some HFTs exited the market for reasons similar to other market participants, such as the triggering of their internal risk parameters due to rapid price moves and subsequent data-integrity concerns, other HFTs continued to trade actively. Among those HFTs that continued to trade, motivations varied, but were in part based on whether they thought their algorithms would be able to operate successfully (profitably) under the extreme market conditions observed that afternoon.”


“In summary, our analysis of trades broken on May 6 reveals they were concentrated primarily among a few market participants. A significant number of those trades were driven by sell orders from retail customers sent to internalizers for immediate execution at then-current market prices. Internalizers, in turn, routed these orders to the public exchanges for execution at the NBBO. However, for those securities in which market makers had withdrawn their liquidity, there was insufficient buy interest, and many trades were executed at very low (and sometimes very high) prices, including stub quotes.”

I guess the econotwisted way to sum this up will be:

On May 5th 2010 all the money in the US stock market disappeared for some reason – and after about 20 minutes they suddenly came back, for some reason….

Here’s a copy of the report.

Have fun!

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SEC Expand Single Stock Circuit Breakers for Russell 1000 Index And Others

The Securities and Exchange Commission approve new rules submitted by the national securities exchanges and FINRA to expand a recently-adopted circuit breaker program to include all stocks in the Russell 1000 Index and certain exchange-traded funds. The SEC also approved new exchange and FINRA rules that clarify the process for breaking erroneous trades, according to a press release.

“These circuit breakers and this more objective guidance on breaking erroneous trades will help our markets retain the confidence of investors and companies.”

Mary L. Schapiro


A list of the securities included in the Russell 1000 Index, which was rebalanced on June 25, is available on the Russell website. The list of exchange-traded products included in the pilot is available on the SEC’s website. The SEC anticipates that the exchanges and FINRA will begin implementing the expanded circuit breaker program early next week.

The circuit breaker pilot program was approved in June in response to the market disruption of May 6 and currently applies to stocks listed in the S&P 500 Index.

Trading in a security included in the program is paused for a five-minute period if the security experiences a 10 percent price change over the preceding five minutes.

The pause gives the markets an opportunity to attract new trading interest in an affected stock, establish a reasonable market price, and resume trading in a fair and orderly fashion.

The circuit breaker program is in effect on a pilot basis through Dec. 10, 2010.

A list of the securities included in the Russell 1000 Index, which was rebalanced on June 25, is available on the Russell website.

The list of exchange-traded products included in the pilot is available on the SEC’s website. The SEC anticipates that the exchanges and FINRA will begin implementing the expanded circuit breaker program early next week.

“These circuit breakers and this more objective guidance on breaking erroneous trades will help our markets retain the confidence of investors and companies,” SEC Chairman Mary L. Schapiro says in a statement.

“We have worked quickly with the exchanges to take these steps, and we will continue to be very focused on addressing weaknesses exposed on May 6.”

The markets will continue to use the pilot period to make appropriate adjustments to the parameters or operation of the circuit breakers as warranted based on their experience.

The erroneous trade rules were developed in response to the market disruption of May 6.

The rules will make it clearer when — and at what prices — trades will be broken by the exchanges and FINRA.

As with the circuit breaker program, these rules will be in effect on a pilot basis through Dec. 10, 2010.

For stocks that are subject to the circuit breaker program, trades will be broken at specified levels depending on the stock price:

  • For stocks priced $25 or less, trades will be broken if the trades are at least 10 percent away from the circuit breaker trigger price.
  • For stocks priced more than $25 to $50, trades will be broken if they are 5 percent away from the circuit breaker trigger price.
  • For stocks priced more than $50, the trades will be broken if they are 3 percent away from the circuit breaker trigger price.

Where circuit breakers are not applicable, the exchanges and FINRA will break trades at specified levels for events involving multiple stocks depending on how many stocks are involved:

  • For events involving between five and 20 stocks, trades will be broken that are at least 10 percent away from the “reference price,” typically the last sale before pricing was disrupted.
  • For events involving more than 20 stocks, trades will be broken that are at least 30 percent away from the reference price.

On May 6, the markets only broke trades that were more than 60 percent away from the reference price in a process that was not transparent to market participants.

By establishing clear and transparent standards for breaking erroneous trades, the new rules should help provide certainty in advance as to which trades will be broken, and allow market participants to better manage their risks.

At Chairman Schapiro’s request, the SEC staff is also:

  • Considering whether market makers should be subject to more meaningful obligations to promote fair and orderly markets.
  • Working with the exchanges to prohibit the use by market makers of “stub” quotes that are not intended to indicate actual trading interest.
  • Studying the impact of multiple trading protocols at the exchanges, including the use of trading pauses and self-help rules.

The SEC staff also intends to work with the markets and CFTC staff to consider recalibrating market-wide circuit breakers currently on the books — none of which was triggered on May 6.

These circuit breakers apply across all equity trading venues and the futures markets.

Related by The Swapper:

May 6. 2010: “The Black Thursday”

Testimony Of A High Frequency Trader

Thursday May 6. – Busiest Day Ever On CBOE

Wall Street Collapse: Did Somebody See It Coming?

David Rosenberg: “The Weirdest 20 Minutes Of My Life”

U.S. Stock Crash Compels Further Investigation of Wall Street Scam

The Rise Of The New Market Makers

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Wall Street Get Smacked Again – Post-Trading Commentary

U.S. stocks sank, with the Standard & Poor’s 500 Index falling to its lowest level in four months, as slower-than-estimated jobs growth spurred concern the economic recovery may not be as robust as forecast. The S&P 500 Index declined 3.4 percent to 1,064.88. It was the biggest drop on the day of the U.S. Labor Department’s monthly jobs report since at least 1998, according to data compiled by Bespoke Investment Group LLC. The Dow sank 324.06 points, or 3.2 percent, to 9,931.22.

“Those who had been expecting a more robust recovery might be cutting down their projections.”

James Dunigan


The S&P 500 erased its weekly advance after the Labor Department said today that payrolls increased by 431,000 in May, trailing the median economist forecast in a Bloomberg News survey that called for a gain of 536,000. Private employers added 41,000 positions, 139,000 less than estimated.

“The jobs report puts a damper on the growth story,” said James Dunigan, chief investment officer at PNC Wealth Management in Philadelphia.

“It’s a victim of the uncertainty that we’ve seen over the last months especially regarding the European situation. Those who had been expecting a more robust recovery might be cutting down their projections.”

Mohamed A. El-Erian, whose firm runs the world’s biggest mutual fund, says stock investors should brace for higher volatility after the jobs report.

“Investors should keep their seat belts on and tight,” El-Erian, chief executive officer of Pacific Investment Management Co, wrote in an e-mail to Bloomberg News.

“The disappointing jobs report is further evidence that drivers of self-sustaining private consumption growth are facing structural problems that result in slow income growth, reduced credit availability and lower ability to monetize wealth.”

The Euro sank below $1.20 for the first time since March 2006, to $1,19550,  amid speculation the European fiscal crisis may be spreading into the financial system.

A Defining Moment

“Every now and then, what starts out as an apparently isolated incident of tragedy or stupidity turns out to be one of those defining events in history. A morning in September at the start of the decade turned out that way, when what seemed, at first, to be an errant act of navigational aerial stupidity turned out to be an initial salvo of terrorism.”

“Now, we have what started out as a human tragedy, the loss of life aboard an offshore rig, turning into a defining moment for the oil industry, national security and domestic oil supply. The BP disaster has turned offshore drilling into a political quagmire, and has destroyed one of our nation’s pillars of domestic oil supply,” analysts at Cameron Hanover writes in a post-trading commentary Friday.

Here’s the rest of the market summary:

“From our perspective, Friday’s biggest story was the Baker‐Hughes report, released after the market closed, which showed half of our nation’s offshore rigs idled. The number fell from 46 to 23, its lowest figure since August, 1993. The moratorium on deepwater drilling gave us our first decline in the rig count in six weeks, and saw it plunge by 29 to 1,506. Gas rigs dropped by 2.1%, or by 20 rigs, to 947. No one has been talking about a “gas spill,” but gas is just the first of what we expect to be many collateral damages.”

“The rig count was not Friday’s motivating force, despite the importance we may read into it. Oil prices dropped steeply, as traders reacted to a collapse in equities, a decline by the euro to less than $1.20, its lowest exchange rate against the US dollar since March, 2006, and an unemployment report which showed much less of an increase in non‐farm payrolls than had been expected. These three factors worked hand‐in‐glove together to generate the huge decline in oil prices.”

“On the charts, crude oil prices had been threatening to break above resistance up to $75.72 on Thursday, but had fallen short of that. Heating oil prices had broken over 203.92, but they finished one point beneath that level, which makes Friday’s decline a technical failure on the charts. That realization seemed to add another element of selling to the mix.”

“From the popularly‐held perspective, Friday’s decline came as the result of the May unemployment figures being disappointing, with a gain in non‐farm payrolls of 431,000 against estimates for a gain of 515,000. Many of the jobs that did materialize came from census bureau positions that are temporary. The euro fell more quickly and sharply after the numbers were released, but it had already been on the ropes because of concerns over Hungarian debt. This was tucked in beside the problems experienced by Greece and others earlier in May. And the US stock market plunged, losing 323.31 points to end at 9,931.97, below the psychologically important 10,000 level.”

“The upshot of this week’s volatile trading is this: US oil demand has increased in recent weeks, but is under pressure by unemployment, which continues to be the millstone weighing around the economy’s neck. Any gains made by the US are being balanced by concerns over European sovereign debt, which has become a can of worms, now that it has been opened. And any hope that consumers might feel cheered by anything has taken a hit with the DJIA breaking below 10,000, a psychologically significant level that leaves investors feeling less wealthy. Oil prices seem to be on the verge of a fresh round of losses. Recent gains now seem to have been part of a rally in a market that is still weak.”

Note: When we do rally or advance for real, the loss of offshore drilling and recent gains in demand now seem likely to lead prices higher. We need to get past everything else, though, first.”

Here’s a copy of the commentary, incl. charts and figures from Cameron Hanover.

Related by the Econotwist:

Rosenberg: “Statistical Illusion Of Recovery”

S&P 500 Drops 3.4% On Disappointing Job Report

Oil Spill Makes Waves

Why Optimists Are Wrong About The Euro Zone

BP Is Drowning In Its Own Oil Spill

Goodbye Keynes – Hello Ricardo!

U.S. Stock Market: Worst Week Since 1940

Merkel, Obama, Sarkozy Have Investors Shitting Their Pants

European Banks: “Leman Times Ten”

Welcome Back to Earth, Mr. Market

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