Flash Crashes in The Stock Exchange

Picture that you are a day trader on the NYSE sitting in your home office trying to make sense of all the data that your multi-screen setup is giving you about the market. It is about 2:30 in the afternoon and the markets have behaved how they usually do and you have made the profit you had planned for the day, happy with your day you go get yourself a cup of coffee only to come back and see that the markets have nose dived with the Dow Jones Industrial Average falling down almost 9%! You panic and in your panic you end up calling your friends and acquaintances trying to figure out what is happening and after a little more than half an hour you are stumped to see that the markets have recovered.

What you read right now was not fiction but a very real flash crash that occurred on May 6th 2010 and showed the world the flip side of algorithmic trading. Flash crashes are sudden dips in the market that are caused when algorithmic trading programs react to aberrations in the market, such as heavy selling in a particular security or securities, and end up placing sell orders at large volumes at an incredibly rapid pace to avoid losses.

Suppose a trader places a large sell order on a particular stock. Now when an algorithm, trading this stock notices this sell order it will be automatically triggered to sell the stock to avoid losses. This selling will now initiate a domino effect which would lead to other High Frequency Trading (HFT) algorithms placing sell orders and cause the value of the stock to fall drastically which could lead to a flash crash. Such crashes are a lot more common than one would imagine with almost 12 mini flash crashes in a day.

What happened on May 6th 2010 was certainly not your average flash crash and was attributed to Navinder Singh Sarao a London based trader. According to the reports Sarao used an automated program to generate large sell orders and then cancel these orders just before they were fulfilled thereby "spoofing" the market and triggering the

Navinder Singh Sarao

algorithms to dump their stocks consequently forcing the prices to fall at no cost to himself. Sarao would then buy the stocks at the lower price to make a profit. In April 2015 Sarao was arrested for his alleged role in the flash crash and had to later pay £50,000 in bail and has recently been sentenced to one year of home confinement in January 2020. After the flash crash of 2010 the officials announced new trading curbs namely circuit breakers, these circuit breakers would halt trading for five minutes on any S&P 500 stock that rises or falls more than 10 percent in a five-minute period.