Four years ago today the Dow Jones Industrials plummeted 1,000 points in a few seconds, spiking fears and inciting chaos across Wall Street.
An erroneous trade was quickly identified for the 9% selloff and the losses were largely recuperated within 10 minutes -- but not without sparking a much-needed conversation about trading practices and market structure.
The markets of today have been outfitted with strict rules designed to defend against bad trades, notably the single stock circuit breakers. But the debate continues, and the question remains: could it happen again?
“Could a flash crash happen again? The answer in our opinion is yes,” said Joe Saluzzi, a partner at institutional agency broker Themis Trading and author of “Broken Markets.”
“Talks have been getting better lately but we are just not there yet,” he said. “Structurally, there are still major issues in the market.”
The discussion has in fact intensified in recent months, especially since the release of Michael Lewis’ new book “Flash Boys” that takes a very critical approach to high-frequency trading (HFT).
The Securities & Exchange Commission and U.S. Commodity Futures Trading Commission have cracked down since 2010, releasing a number of recommendations on how to improve market structure, transparency and responsibility. It has not yet been able to address them all.
“There is always the risk of disruption, the question is how large?"
- The Clearpool Group CEO Peter Kenny
Saluzzi says many of the rules enacted since May 2010 have been “cosmetic.” Deeper issues such as data feeds, the maker-taker model and obligations of market makers remain outstanding.
Single stock breakers, for example, which currently halt stocks that move beyond a specific price threshold -- either 5% or 10%, depending on the security – during a five-minute period, wouldn’t be enough by themselves to stop a multi-point stock market decline caused by erroneous trades or a glitch.
However, Peter Kenny, CEO of trading firm The Clearpool Group, says a flash crash reoccurrence of the same magnitude is “exceptionally unlikely.”
“There is always the risk of disruption, the question is how large?” he said. “A flash crash-like experience is less likely than it was four years ago – and I think regulators are going to go out of their way to prevent anything from taking place that disrupts the slow, gradual return of confidence in the U.S. equity markets.”
Just last week, New York Attorney General Eric Schneiderman reportedly began probing exchanges, including IntercontinentalExchange (ICE), Nasdaq (NDAQ) and BATS, and alternative trading platforms, regarding their relationship with HFT firms and whether electronic trading platforms are at an advantage compared to, say, mom and pop retail investors.
HFT has become a fixture of modern-day trading, responsible for millions of trades a day.
But prior to the crash it was largely an unknown phenomenon to the regular non-Wall Street investor. That is partly why the crash was such a big deal – it brought HFT to the mainstream and sparked a needed chat.
“The flash crash was the wake-up call,” Kenny said. “The fact that all those things were brought to the floor in a few moments, the subsequent conversation was elevated to a new level.”
The Dow Jones Industrial has climbed nearly 60%, or some 5,700 points, to record levels since May 2010 – including a near 100-point decline on Tuesday. Kenny says the markets are “performing brilliantly” now and not just because of their record highs; spreads have also tightened, and commission rates have come down significantly over the last few years.
That said, HFT is not going away – it simply will evolve as the market evolves.
“I don’t personally feel as though there is any moral imperative to denigrate or critically pick a part HFT because there are both positives and negatives,” Kenny said. “There will continue to be an evolution in the thought that leads to a better price discovery experience for investors and the public.”