...So, the market was ripe for a catastrophic event, because it was so saturated with stop orders, all it needed was a catalyst. And the catalyst occurred, according to a couple of Reuters reporters, because a large mutual fund complex, decided to do a $4.5B hedging transaction in e-mini futures contracts, which track the S&P 500 index, when the market was already in that vulnerable state.
Scott: Most of those were actually transacted on the way up.
Manoj: Right, but the orders were entered prior to the huge collapse, and that’s the important part. On an ordinary day, an order of that size, and that’s a pretty substantially sized order, would definitely have had a ½% or 1% price impact. But on this day, when volatility was already elevated, and the market was just looking for a reason to take profits, it had an outsize effect, and very likely triggered the first wave of stops, which then turned into market orders, which then led to a gigantic spike in volume. What happened then, in relatively short order, was that the Arca exchange (which is owned by NYSE), fell behind, in terms of its ability to process quotes. Continue reading...
I found it somewhat stunning and slightly amusing that the events above led to a congressional investigation. Despite all the hand wringing over the "flash crash" it is difficult to view it as more than a distraction for regulators. These are my reasons:
- Its impacts were solely in the secondary market. With every winner producing a loser, it is hard to see any market conspiracy to create such events. The most obvious way this self-corrects is by increasing traders' preference for limit orders over market orders.
- While liquidity gaps don't happen often in large liquid markets like the S&P futures, they should not take anyone by surprise. The crash of 1987 is referenced above and is an obvious example. Another more recent example is the gap that occurred in the Japanese Yen in the
fallAutumn of 1998 (from 120 down to 112 without trading as I recall) when a large hedge fund asked for a bid to stop out. * - The most pressing problem facing regulators is how to identify and react to market dislocations that accumulate over years. Housing prices, the dot.com boom, the Japanese property and equity bubbles in the 1980s...etc. These market distortions don't focus attention on themselves the way a one day drop does but lead to excess debt and a mis-allocation of resources that reduce growth for years.
*As an aside, it is interesting that the 1987 S&P crash, the Yen gap, and the 2010 flash crash were all driven by unusually large hedging orders. When markets make sharp price moves, traders need to make a snap decision about whether the price move represents a signal or just noise. Usual questions to ask are: 1) How much volume is in the move? 2) Is the seller likely to reverse direction in the near-term? and 3) How many other people are likely to do the same? A massively out-sized hedging order from a large long-term player following a common strategy will always give the impression that the order is a signal. In that instance, men and the machines they build will reach the same conclusion and let prices gap.
No comments:
Post a Comment