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Flash crash shows how quick-draw traders dominate market
By Lynn Thomasson, Paul M. Barrett and Nina Mehta
Clarence Woods was attending a community college near Baltimore in 1982 and playing drums in a wedding band when one day, to his surprise, the financial world beckoned. "They were so desperate for anyone who knew anything about computers," Woods recalls. "If you could spell the word, you had the job." He swiftly moved from the back office at the brokerage Legg Mason to Equitable Bank, where he installed Quotron stock price machines. In 1985 he made his first purchase as a rookie trader: 100 shares of IBM on the New York Stock Exchange.
On May 6, Woods, now 47, realized how radically his industry has changed. He had just started his own hedge fund after quitting as chief equity trader at MTB Investment Advisors, a $13 billion money manager in Baltimore. He was working at home when the trouble hit. "I was doing some small trades, and had a lot of puts set up, and all of a sudden they just went berserk," he says. "Then I started to panic."
His first thought was that cyber-savvy extremists had infiltrated the fiber-optic network on which automated programs now trade securities tens of thousands of times a second. With no terrorism reports surfacing, Woods shifted his suspicion to the nature of the contemporary market itself: hyper-accelerated, decentralized, and, in important ways, beyond human supervision. "I thought, 'My God, I bet you're sure going to miss the New York Stock Exchange now.'"
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A lot of people felt nostalgia for Big Board dominance on May 6. The fleet computers that drive today's securities industry are astounding and unsettling. "Wall Street is no longer what it was designed to be," Mark Cuban, the tech entrepreneur, veteran investor, and owner of the Dallas Mavericks basketball team, blogged after watching the frantic selloff. "Wall Street is now a huge mathematical game of chess where individual companies are just pawns."
Hysterical Thursday did no apparent long-term harm. Some venerable stocks dropped to a penny apiece before bouncing back. Overall, the Standard & Poor's 500-stock index declined 6.2 percent, from 1,136.16 to 1,065.79, in a 20-minute spanan $862 billion paper lossbefore recovering to finish down 3.2 percent.
Still, the brief crash threw up a flare that illuminated a financial topography that was unfamiliar even to many experienced investors. A Bloomberg Businessweek investigation into those harrowing minutes revealed the extent to which the market is now dominated by quick-draw traders who have no intrinsic interest in the fate of companies or industries. Instead, these former mathematicians and computer scientists see securities as a cascade of abstract data. They direct their mainframes to sift the information flows for minute discrepancies, such as when futures contracts fall out of sync with related underlying stocks. High-frequency traders (HFTs), as they're known, set an astonishing pace. On May 6, 19 billion shares were bought and sold; as recently as 1998, 3 billion shares constituted a very busy day.
The HFT wizards argue that all that extra buying and selling provide the liquidity that makes the market more efficient. As long as the machines are humming, electronic bids and offers abound. On May 6, however, we saw what happens when digital networks follow conflicting protocols and some of the mighty computers temporarily power down. Liquidity evaporates. Panic combined with automation leads to much faster panic.
The decline began midmorning as skittishness intensified over the Greek economic debacle spreading elsewhere in Europe. A closely watched gauge of volatility calculated by the Chicago Board Options Exchange hit a high point for the year at 2:08 p.m. The volatility index, or VIX, is derived from options on the S&P 500, and it measures investor perceptions of market risk. When the VIX surged again, in its biggest gain in three years, some high-frequency programs may have automatically slowed their normal pace to limit losses, according to a May 15 research note by Nomura Securities.
Sell orders piled up much faster than buys, an imbalance that worsened over the next hour. During the period of heaviest selling, starting around 2:30 p.m., the NYSE paused electronic trading in certain stocks and switched to computerized auctions conducted by human traders. This caused electronic sell orders to be rerouted to other trading venues, where there were few, if any, buy orders to absorb them. As Mary L. Schapiro, chairman of the Securities & Exchange Commission, put it in congressional testimony five days later, some high-frequency firms "withdrew their liquidity after prices declined rapidly."
During the next few hours of confusion, exchanges began canceling trades in hundreds of stocks. NYSE Arca, an electronic platform operated by the Big Board, erased transactions in 295 companies. A surge in trades rejected by exchanges constitutes another trigger that automatically causes some high-frequency firms to slow down, says Ethan Kahn, a principal at Wolverine Trading, an electronic market-making outfit in Chicago: "You disable. You shut down." Wolverine pared back activity in equity futures because of concerns about the accuracy of data it was receiving, he adds.
CONTINUED : SEC investigates1 | 2 | 3 | Next >
What really happened to markets on May 6? - Bloomberg Businessweek- msnbc.com
By Lynn Thomasson, Paul M. Barrett and Nina Mehta
Clarence Woods was attending a community college near Baltimore in 1982 and playing drums in a wedding band when one day, to his surprise, the financial world beckoned. "They were so desperate for anyone who knew anything about computers," Woods recalls. "If you could spell the word, you had the job." He swiftly moved from the back office at the brokerage Legg Mason to Equitable Bank, where he installed Quotron stock price machines. In 1985 he made his first purchase as a rookie trader: 100 shares of IBM on the New York Stock Exchange.
On May 6, Woods, now 47, realized how radically his industry has changed. He had just started his own hedge fund after quitting as chief equity trader at MTB Investment Advisors, a $13 billion money manager in Baltimore. He was working at home when the trouble hit. "I was doing some small trades, and had a lot of puts set up, and all of a sudden they just went berserk," he says. "Then I started to panic."
His first thought was that cyber-savvy extremists had infiltrated the fiber-optic network on which automated programs now trade securities tens of thousands of times a second. With no terrorism reports surfacing, Woods shifted his suspicion to the nature of the contemporary market itself: hyper-accelerated, decentralized, and, in important ways, beyond human supervision. "I thought, 'My God, I bet you're sure going to miss the New York Stock Exchange now.'"
Story continues below ↓advertisement | your ad here
A lot of people felt nostalgia for Big Board dominance on May 6. The fleet computers that drive today's securities industry are astounding and unsettling. "Wall Street is no longer what it was designed to be," Mark Cuban, the tech entrepreneur, veteran investor, and owner of the Dallas Mavericks basketball team, blogged after watching the frantic selloff. "Wall Street is now a huge mathematical game of chess where individual companies are just pawns."
Hysterical Thursday did no apparent long-term harm. Some venerable stocks dropped to a penny apiece before bouncing back. Overall, the Standard & Poor's 500-stock index declined 6.2 percent, from 1,136.16 to 1,065.79, in a 20-minute spanan $862 billion paper lossbefore recovering to finish down 3.2 percent.
Still, the brief crash threw up a flare that illuminated a financial topography that was unfamiliar even to many experienced investors. A Bloomberg Businessweek investigation into those harrowing minutes revealed the extent to which the market is now dominated by quick-draw traders who have no intrinsic interest in the fate of companies or industries. Instead, these former mathematicians and computer scientists see securities as a cascade of abstract data. They direct their mainframes to sift the information flows for minute discrepancies, such as when futures contracts fall out of sync with related underlying stocks. High-frequency traders (HFTs), as they're known, set an astonishing pace. On May 6, 19 billion shares were bought and sold; as recently as 1998, 3 billion shares constituted a very busy day.
The HFT wizards argue that all that extra buying and selling provide the liquidity that makes the market more efficient. As long as the machines are humming, electronic bids and offers abound. On May 6, however, we saw what happens when digital networks follow conflicting protocols and some of the mighty computers temporarily power down. Liquidity evaporates. Panic combined with automation leads to much faster panic.
The decline began midmorning as skittishness intensified over the Greek economic debacle spreading elsewhere in Europe. A closely watched gauge of volatility calculated by the Chicago Board Options Exchange hit a high point for the year at 2:08 p.m. The volatility index, or VIX, is derived from options on the S&P 500, and it measures investor perceptions of market risk. When the VIX surged again, in its biggest gain in three years, some high-frequency programs may have automatically slowed their normal pace to limit losses, according to a May 15 research note by Nomura Securities.
Sell orders piled up much faster than buys, an imbalance that worsened over the next hour. During the period of heaviest selling, starting around 2:30 p.m., the NYSE paused electronic trading in certain stocks and switched to computerized auctions conducted by human traders. This caused electronic sell orders to be rerouted to other trading venues, where there were few, if any, buy orders to absorb them. As Mary L. Schapiro, chairman of the Securities & Exchange Commission, put it in congressional testimony five days later, some high-frequency firms "withdrew their liquidity after prices declined rapidly."
During the next few hours of confusion, exchanges began canceling trades in hundreds of stocks. NYSE Arca, an electronic platform operated by the Big Board, erased transactions in 295 companies. A surge in trades rejected by exchanges constitutes another trigger that automatically causes some high-frequency firms to slow down, says Ethan Kahn, a principal at Wolverine Trading, an electronic market-making outfit in Chicago: "You disable. You shut down." Wolverine pared back activity in equity futures because of concerns about the accuracy of data it was receiving, he adds.
CONTINUED : SEC investigates1 | 2 | 3 | Next >
What really happened to markets on May 6? - Bloomberg Businessweek- msnbc.com
