Another Flash Crash Hits Wall Street

A Flash Crash hit all major US stock markets this afternoon when a hacked Associated Press alert appeared which stated that two major explosions occurred at the White House, injuring President Barack Obama. Within seconds all the major stock indexes - the Dow Jones Industrials, the S&P 500, and the NASDAQ, began plummeting. The Dow, which had been up over 130 points, lost all of that gain and quickly fell to negative territory. All other indexes followed.

Within a few minutes AP announced that its Twitter account had been hacked, and the claim that there was a bombing at the White House was phony.  Stocks began an immediate surge higher and within three minutes the Flash Crash was over - stocks had recovered all the ground last in the crash.

Years ago, when humans were in charge of the stock markets, false stories appeared from time to time and never caused a complete collapse of the markets. There might be something of a sell-off, but humans have a capacity of judgment that lets them exercise skepticism over certain news stories. The computers which are running the stock markets these days have no such capacity of judgment. They merely react instantaneously to any news that they are programmed to recognize as negative. They also react collectively - every computer at every bank and brokerage house seems to be programmed with the same instinct to sell bad news aggressively. This is the genesis of a flash crash; several hundred mega-computers sending thousands of sell orders in each nanosecond, at the same time.

Computers are also programmed never to catch a falling knife. Humans, on the other hand, if they were working as Wall Street specialist brokers, were required to step in and buy the market if a crash began to occur in any stock or index. Specialist brokers are relics of the past, and while the people who run the computers which run Wall Street allege that their businesses provide liquidity to the market in times of stress, all the evidence points to the opposite. Computers withdraw liquidity in times of stress - that much has been proven over and over with hundreds of Flash Crashes in recent years occurring with individual stocks, and the occasional over-all market collapse.

Nothing has changed since the May 6, 2010 Flash Crash which wiped out over 1,000 Dow points in 20 minutes. If anything, things have gotten worse. The SEC has claimed it has done much to solve the problem, but the algorithms which control the market - the "algos" as they are called" - remain many steps ahead of the government regulators. There are many obvious fixes to this problem. The algos regularly submit thousands of orders to the stock exchange computers per nanosecond, and then withdraw them, with no intention of having these orders filled. This manipulates prices up or down and allows the algos to take small profits on each manipulation. The SEC could lengthen the time that must elapse before an order can be rescinded. The SEC has declined to do this, possibly because it would destroy one of the principal money making (that is, rent seeking) businesses on Wall Street.

There is another solution that Congress will some day be tempted to impose, and which already is being legislated in Europe - a small tax on each buy and sell transaction on Wall Street. Speculative activity has dried up 85% in Europe where such a tax is levied. Congress will not be tempted to take this route unless a) it is desperate for revenue, or b) it is fed up with Flash Crashes.

The second option could be adopted sometime in the future, simply because Flash Crashes are now deemed an inevitable cost of doing business by Wall Street. Someday, however, one of these Flash Crashes is not going to recover in a manner of minutes. Someday the rumor that propels the market into a crash is going to be true, and a market that exists on air pumped up by algos will be completely exposed at enormous cost to investors.

Yesterday a survey came out which showed that fully 75% of small investors (Mom and Pop as they are known), refuse to put money back into the stock market. Memories of the dot.com collapse, the 2008 collapse, and the 2010 Flash Crash remain vivid in the minds of many small investors. The press will probably not make a big deal of today's Flash Crash, but it should. The stock market is as dangerous as it has ever been. The stock market is at record highs due to incessant money printing, and a promise of endless money printing, by the Federal Reserve. The record highs have nothing to do with economic conditions or corporate earnings, both of which have been worsening over the past year. Along with the phoniness of the records being set, you add the fact that the liquidity in the market can be withdrawn completely within nanoseconds, and you have the makings of a monstrous stock market crash in the making. This is why the Fed finds it more and more difficult to stop its Quantitative Easing programs; the day that happens the algos will pull out of the market en masse, and the resulting crash will be uglier than the one which occurred in 1929.

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Comments

wow, how to manipulate markets in nanoseconds

How much money was made off of one phony tweet? Nothing better than having automated programs operating off of inputs that then trade in the pico-seconds trillions of dollars and Congress, the world, sits on their hands acting like somehow once one gets into engineering, computer science, technology they cannot possibly regulate...probably because they are so clueless on what technology means financially, economically, in terms of regulation.

Notice that, anything involving a latency of a cable, router or has any math in it is completely ignored by regulators?

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