The 1,000 point drop (better) explained

[Kurt_and_Hunter]

A good metaphor to start with is a tsunami. At sea a tsunami looks just a modest hump of water moving along at a good clip through deep water. As it approaches shore the water becomes shallow and the same size mass of water has to fit in a lot less area and it's an explosive event, with the wave rising to seventy or a hundred feet.

For some reason --fat-fingers, software bug or whatever-- some stocks started showing hard-to-believe price action simultaneously. It really doesn't matter whether it was a careless Citi trader or Mrs. O'Leary's cow. The key is that whatever it was, it caused the next step that was the real cause of the crisis: The New York Stock Exchange said, "That looks like a computer error or something..." and they stopped electronic trading, reverting to the slow old-style manual market-maker set-up.

Back in the day that would have worked fine.

But today electronic orders on the NYSE can be filled on a lot of electronic exchanges. Notably NASDAQ, but also London and a bunch of other markets.

Those other venues do not, however, have a fraction of the volume in NYSE stocks that the NYSE does. They are shallow. An imbalance of buy/sell interest that would normally drop stock X a dollar is magnified.

Your order to sell a million shares of stock X is suddenly cut off from electronic NYSE orders to buy stock X. And nobody in the other electronic markets happens to want a million shares of stock X. If they wanted a million shares of stock X they would place their order through the NYSE market-maker in stock X. But he is suddenly out of the picture. So without any buyers the price drops straight down.

(Electronic buy orders were also shunted to low volume markets but the market was dropping sharply at the time so the action was unbalanced. The average order was a sell and the magnification was to the down-side. If the trades shunted into thin markets were mostly buy orders we might have seen a startling spike.)

The NYSE watched the DOW drop 600 points in a minute (D'oh!) and realized that their idea of suspending electronic trading wasn't as smart as it had seemed and resumed electronic trading. Suddenly there was a high volume of available buyers and sellers and prices zoomed up almost as fast as they had fallen.

In tsunami terms, the wave goes back out to sea and drops from seventy feet back down to three feet but contains the same amount of water. Stocks were way down yesterday on merit. The market is over-priced, the European situation is FUBAR. This electronic issue did not cause yesterday's down closing. It did, however, cause about half of the brief 1,000 point drop.

[phleshdef]

1. Something like 60% of the market is setup for automatic trades to occur under certain conditions.

So when someone put in that billions of P&G shares were being sold, when the number was considerably less, it set off a chain reaction of automatic trading which caused the DOW to plunge 700 points over the course of 10 minutes.

My question is though is why was the faulty trade allowed to go through in the first place. Myself, being a business applications developer, I don't see how in the world there weren't validations in place to detect a faulty trade like that the moment it was entered.

[northernlights]

6. because financial people are notoriously cheap

so they had their crappy system planned, designed and built by the cheapest outfit they could find?

[RM33]

8. Not true

I worked in the IT field in Wall Street. Wall Street is the cutting edge of technology. They always have the latest software, hardware and crack programmers. They have to, because if they fall behind in tech, they are finished.

Are they perfect? No. No one is perfect. But compared to other industries and the government, Wall Street is near perfection. Trillions of trades are conducted in a year. And every penny is accounted for. Compare that to government where votes are routinely lost or miscounted.

[mopinko]

11. what rm333 says is absolutely correct

it butters my bread, and i can tell you that their tech is the best there is.

[ljm2002]

2. Thank you for that explanation...

...it is the first one I've heard that makes sense of the weird and wild price plunges / rises for some stocks but not others.

[Kurt_and_Hunter]

3. ...

[Statistical]

4. One thing I would add is this is where regulation is needed.

The NYSE did the right thing. It was obvious whoever was selling some of these stocks was way out of control. Billions upon billions of dollars in sell orders being dumped on the market in milliseconds. Even the most corrupt brokerage and hedge isn't stupid enough to do this intentionally. By flooding the sell side they destroyed any demand from buyers and the stock sunk like a stone meaning with each further trade the seller collected less and less money. Obviously a mistake. How/why is something to figure out later.

In that moment the NYSE had safeguard to break the high frequency trading cycle and slow the market down.

NYSE has asked other exchanges that when it institutes "liquidity curbs" that they join in. On NYSE the market execution time went from 1/1000th of a second to 30 seconds however the other 100% electronic exchanges see this as a chance to get some market share and keep allowing high speed trading.

Of course it is obvious the don't have the depth to handle 100% of order flows and the system collapsed. Liquidity dries up on buy side almost instantly and even new buy orders coming in aren't fraction of what is needed to balance the market. The stocks and then indexes begin to plummet.

Congress should pass some regulations requiring a universal set of circuit breakers. If one exchange slows down due to extreme volatility they all slow down working together to slow effects of a flawed High Frequency Trading program. Current it is every man for himself. Obviously this doesn't work.

Secondly there should be some massive restrictions on High Frequency Trading.

[AnArmyVeteran]

5. I'm sure a 'President Palin' would understand all this...

[Kurt_and_Hunter]

7. I have always been leery of multi-exchange trading

My libertarian side applauds multi-markets but my flinty yankee side says if you can't lose enough money between 9:30-4:00 you're not trying hard enough.

Thin markets, like after-hours trading, are supposed to bleed off tension but they are also able to create tension.

IIRC, the 1987 crash started in London with American mutual funds desperately trying to cover Friday's big sell orders early Monday in London before the NYSE opened. A calculated risk, but one that crushed US equities in thinner trading before New York opened.

[B Calm]

9. The predatory capitalists bastards should be in jail! The market drops

after the senate vote!

[mopinko]

10. nyse did not shut down

and dh, who works in the field, says that your explanation is not correct. "little" markets do not really exist. they are interconnected and perfectly capable of handling the volume that went around this.
the b for m explanation IS what happened, he says. you will have to wait to see if that is borne out by the investigation.

[Kurt_and_Hunter]

12. A large sell order could hardly have caused Sotheby's stock to

go to $10,000/share. These are behaviors of an inability to match both sides of an order... they are the things that would be expected if a market were throttled down to extreme "thinness"

A gigantic sell-off of Procter and Gamble stock could not do that.

If it's incorrect it is incorrect. I am, of course, relying on public information. This is not my theory. This is the official explanation as of the time the OP was written. It is an attempt to explain the official explanation to folks who don't follow this stuff much, not to posit a personal theory.

(And I was not saying the NYSE ever shut down. Suspending electronic transactions for one or two minutes isn't shutting down.)

[yella_dawg]

13. I think we're at war.

A hot war fought with computers in the financial sector.

A couple of earlier replies point out that the financial sector owns what is quite likely the most advanced computer hardware and software in existence. This wasn't a glitch in the sense most people think of computer glitches. Heavy financial software is constantly monitored and maintained to prevent this sort of thing.

Several responsible, public, figures referred to the 2008 financial collapse as a "coup". I've seen no evidence that this was an unreasonable description. Indeed, I think the current activity in constructing a so-called banking regulation bill is clear proof that the US Government is totally dominated by the financial industry. Certainly the weaker members of the EU are under economic assault. The situation in Greece stems from financial attack, not mismanagement (though that exaggerates the problem). I think this most recent stock market swing was simply a hot-spot battle. Remember this went on for days, radical swings in the market, during our financial collapse in 2008.

Imagine that. A war, and no one notices. Ain't technology wonderful.



Have Fun,


John

[bemildred]

14. Global markets are chaotic and unpredictable.

They are prone to catastrophic transitions, and those are occurring more frequently as time goes on.

[Catshrink]

15. DUer n2doc explained it this way:

http://www.democraticunderground.com/discuss/duboard.php?az=view_all&address=389x8299949