The 2010 Flash Crash

On the afternoon of 6 May 2010, US stock markets suffered one of the fastest crashes in history. Within minutes, major indices fell around 9%, briefly erasing close to $1 trillion of market value, and then recovered most of the loss. Some stocks traded at absurd prices, as low as one cent, while others printed at $100,000 a share. The Flash Crash exposed how fragile liquidity can be in fast, fragmented, electronic markets and led to new safeguards such as single stock circuit breakers.

What happened#

The Dow Jones Industrial Average fell nearly 1,000 points intraday, about 9%, before closing down about 3%.

The causes, according to regulators#

The joint SEC and CFTC report published in September 2010 described a chain of events:

1. A large fundamental trader began selling 75,000 E mini contracts, worth about $4.1 billion, using an algorithm that targeted a share of trading volume without regard to price or time.
2. High frequency traders initially bought, then quickly sold to each other and back into the market, generating huge volume. See High-Frequency Trading.
3. Because the algorithm sold more as volume rose, the surging volume accelerated its selling.
4. Liquidity evaporated: many market makers withdrew or widened quotes dramatically.
5. Stub quotes, placeholder orders at absurd prices like $0.01, were executed when no other orders remained. See The Order Book and Market Depth.

Spoofing and Navinder Sarao#

In 2015, US authorities charged Navinder Sarao, a trader in London, with spoofing E mini futures, including on the day of the Flash Crash. He pleaded guilty in 2016. Prosecutors argued his activity contributed to market conditions that day; the original regulatory report focused on the large sell program and liquidity withdrawal. See Spoofing and Layering.

Rules that followed#

Lessons for traders#

1. Liquidity can disappear in seconds, especially when everyone wants to sell. See Liquidity Risk.
2. Stop orders become market orders and can fill at terrible prices in a flash crash. See Stop-Limit Orders.
3. Execution algorithms need price limits and safeguards.
4. Displayed depth is not guaranteed. See Market Data Levels: Level 1, 2 and 3.
5. Some trades were cancelled, but not all; traders bore real losses.

Sources#

• SEC and CFTC, "Findings Regarding the Market Events of May 6, 2010": https://www.sec.gov/news/studies/2010/marketevents-report.pdf

Frequently asked questions#

What was the 2010 Flash Crash?#

A sudden collapse and recovery in US stock prices on 6 May 2010, when major indices fell about 9% within minutes before rebounding.

What caused the Flash Crash?#

Regulators pointed to a large automated futures sell order interacting with high frequency trading and a sudden withdrawal of liquidity; a trader was later convicted of spoofing that contributed to conditions.

Could a flash crash happen again?#

Smaller flash events have occurred since, but safeguards such as Limit Up Limit Down halts now reduce the chance of extreme prices in individual stocks.

Next, learn about the crisis that troubled Europe in The European Debt Crisis.