Different strokes for different folks.
While the equities markets are digesting the official report on the May 6 "flash crash," which documents the facts and events surrounding that tumultuous trading day, some strong opinions are surfacing regarding the accuracy of its findings.
The Securities and Exchange Commission and Commodities Futures Trading Commission released their official joint report on Oct. 1. It found that on May 6, at 2:32 p.m., against a backdrop of unusually high volatility and thinning market liquidity, a large fundamental trader–a mutual fund firm–used an algorithm to sell a total of 75,000 E-Mini contracts with a notional amount of approximately $4.1 billion to hedge an existing equity position. This, the regulators said, was the sole root cause of the flash crash.
Not so, said Alison Crosthwait, director of global trading research at agency brokerage Instinet. According to her research, while the CME E-mini futures order could be considered large, it wasn’t huge, given that the average volume in E-mini futures exceeds 1 million contracts per day. Using the 9 percent participation rate cited by the report, she has concluded that the "large fundamental seller" would only have been selling 12,600 contracts against the 140,000 traded by high-frequency traders between 2:41 and 2:44 p.m. Given that 140,000 is a gross number with only a net 2,000 contracts sold, selling 12,600 contracts in this environment on a normal day could hardly have caused markets to spiral downward.
"Based on our research, we do not find pinning the only cause of the ‘flash crash’ to a single order satisfying," Crosthwait said. "However, the interconnection among markets, the order and the method with which it was executed likely served as a catalyst for the reduction in liquidity and the ‘erroneous’ stock trades experienced seconds later." She feels the trade could be a catalyst, but not the lone cause of May 6’s events, as the SEC claims.
Market data analysis firm Nanex also found the SEC-CFTC report troublesome. Nanex too examined the trade data from May 6, focusing on trades executed by Waddell & Reed–the presumed originator of the sell algo–and its executing broker in the June 2010 E-Mini futures contract. Based on its own research and interpretation, Nanex concluded that the regulator’s report "did not make sense."
The firm said that, when comparing the Waddell & Reed trades with others during that time period, the Waddell trades did not appear to be significant. Furthermore, the data show that the Waddell trades also did not occur near the "ignition point"–the exact start of the crash. Furthermore, Nanex added, the trades are practically absent during the massive sell-off that began less than two minutes later.
According to Nanex, the bulk of the Waddell & Reed trades occurred after the market bottomed and began rocketing higher–a point in time when the SEC report said liquidity in the market dried up. The firm also said that the trade data appeared to show that the sell algorithm did take price into consideration when executing, contrary to the SEC-CFTC report’s claim.
For its part, the SEC stands by the report’s findings. Furthermore, others affirmed the report’s content.
"I thought that the report was pretty accurate for such a complex event," said Jamie Selway, managing director at Investment Technology Group. "I thought it was pretty comprehensive. All in all, it was an A, A-minus at worst."
Matt Andresen, co-chief executive officer of Headlands Technologies, an electronic quant trading firm, said the report met its mandate: to provide a factual account of what happened. Furthermore, he said, the regulator should be lauded, as it didn’t wait for the joint report to be released before implementing solutions to problems exposed on May 6. It put forth single-stock circuit breakers and prohibiting of the use of "stub quotes."
"So the Commission took immediate direct action to address the embarrassing aspects of the flash crash," Andresen said at a recent industry conference.
Selway did say that the final report, while comprehensive in nature, was neither exhaustive nor authoritative. It failed to advocate for any policy changes, such as the next generation of circuit breakers, limit up/limit down or stronger market-maker obligations. Also, the report needed recommendations on how to better analyze data, he said, which could be addressed by mandating a consolidated audit trail.
"The SEC and CFTC staffs could have made recommendations in the report, but left those for another day," Selway said. "While it was a good finding of fact, it is a few months after the event. Market confidence might have been impaired because of the delay. Faster delivery would have been helpful, but maybe not possible."
