Saturday, May 08, 2010

Are flash orders to be blamed for Dow's 1,000 points drop?

Before the smoke is clear, fingers are already pointing at flash orders. See these two NYT pieces here and here. Our reader Madan has convinced me previously that flash orders can indeed be used to  front-run other traders, but until more evidence comes in, I am yet to be convinced that they are the main culprit. Couldn't old-fashioned automated momentum programs accomplished the same thing after an initial erroneous transaction price and/or quote was reported? Perhaps you know of discussions elsewhere on the blogosphere that bring more light to the issue?


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Steve said...

What a wild day that was!

My hunch is that HFT was a signficant part of the rapid price movement. As HFT now makes up a large portion of volume/liquidity, I suspect that they pulled the liquidity as part of risk control. Thus, the mkt was no bid for a short period of time.

I actually had one of my best days on Thursday as it was great for moving pairs around. Twice though, I was so concerned about the wild prints that I turned the program off as it was firing orders left and right.

Ernie Chan said...

I agree with you.

This may actually be a good experiment to showcase what happened when there are no HF traders around to offer liquidity. (Note to Paul Krugman: be careful what you wish for!)

One thing I still don't get: why would people submit SELL @ MARKET orders when clearly chaos ruled? What sane person would sell ACN at $0.01?


jb said...

Actually, the way stop losses work could also cause that? Once the price goes below the stop point, a market order is submitted. I'm sure there were still some people who got caught via market orders but my point is it could also have been stop loss orders.

Jez - Automated Trading Systems said...

Whatever the root cause of this sharp drop, HFT has definitely changed the landscape and dynamics of the market.

Systematic trading systems need to adapt to these changes.

Kill or be killed, unfortunately, this is the law of evolution at play!

Ernie Chan said...

You have a good point -- it is probably due to stop orders, which is why I haven't used stops for years!

trend follower said...

Jez, my way to handle it is to just not play in the intra-day timeframe...

Anonymous said...

I'm amazed how many people are calling for regulation to prevent this happening again. That's all wrong. To me the best solution is free market. For example, now that it's happened once I'm sure there are plenty of punters (automated or not) waiting to take advantage of further spikes. I'll take as much Accenture for a penny as you can give me thanks :)


DanR said...

Ernie any thoughts on using "stop loss %" as a free parameter in a pairs trading optimization?

Ernie Chan said...

I am against the use of stoploss in any mean-reversion strategy. Pairs trading is typically mean reverting. Please see p. 143 of my book for explanation ("What is Your Exit Strategy").