Flash Crash

What Is a Flash Crash?

The term flash crash refers to an event in the electronic securities markets wherein stock withdrawal orders rapidly amplify price declines before quickly recovering. The result of a flash crash appears to be a rapid sell-off of securities that can happen over a few minutes, resulting in dramatic declines. But as prices by the end of the day, it's as if the flash crash never happened.

Key Takeaways

  • A flash crash refers to rapid price declines in a market or a stock's price because of a withdrawal of orders followed by a quick recovery—usually within the same trading day.
  • High-frequency trading firms are said to be largely responsible for flash crashes in recent times.
  • Regulatory authorities in the U.S. have taken rapid steps, such as installing circuit breakers and banning direct access to exchanges, to prevent flash crashes.
  • The biggest drop in DJIA's history occurred on May 6, 2010, after a flash crash wiped off trillions of dollars in equity.
  • According to some estimates, there are approximately 12 mini flash crashes that happen on any given day.

How Flash Crashes Work

As noted above, flash crashes happen when securities prices make drastic drops and rebound very quickly—all within the same day. It almost seems as though the crash never even happened by the end of the trading day. This was the case when the U.S. market experienced a sudden drop on May 6, 2010, and recovered by the end of the day.

Flash crashes are exacerbated by aberrations in the market, such as heavy selling by high-frequency traders in one or many securities. As such, computer trading programs automatically react to these conditions and begin selling large volumes of securities at an incredibly rapid pace to avoid losses.

Flash crashes can trigger circuit breakers at major stock exchanges like the New York Stock Exchange (NYSE), which halt trading until buy and sell orders can be matched up evenly and trading can resume in an orderly fashion.

As trading becomes more digitized, flash crashes are usually triggered by computer algorithms rather than a specific piece of market or company news that causes the quick sell-off. As the price continues to drop and more benchmarks are triggered, it can cause a domino effect that sets off a sudden plunge in value. That being said, a lot more research is needed on flash crashes, including any indication of fraudulent activity.

Although the activity of high-frequency traders is directly linked to flash crashes (and is often a main consideration), it's important to note that there can be many other attributing factors—many of which can be hard to pinpoint.

Preventing a Flash Crash

The propensity for glitches, errors, and flash crashes is much higher, now that securities trading is a heavily computerized industry driven by complicated algorithms across global networks. That said, global exchanges like the NYSE, Nasdaq, and the Chicago Mercantile Exchange (CME) have stronger security measures and mechanisms in place to prevent them and the staggering losses they can lead to.

For example, they have put in place market-wide circuit breakers that trigger a pause or complete stop in trading activity. A decline of 7% or 13% in a market's index from its previous close halts trading activity for 15 minutes. A crash of more than 20% halts trading for the rest of the day.

The Securities and Exchange Commission (SEC) also banned naked access or direct connections to exchanges. High-frequency trading firms, which have been blamed for precipitating the flash crash's effects, often use their broker-dealer's code to access exchanges directly. Such measures cannot eliminate flash crashes altogether, but they have been able to mitigate the damages they can cause.

Examples of Flash Creashes

One of the most famous examples of a flash crash in recent history occurred on May 6, 2010. It began shortly after 2:30 p.m. when the Dow Jones Industrial Average (DJIA) fell more than 1,000 points in 10 minutes—the biggest drop in history at that point. The index lost almost 9% of its value within the hour. Over $1 trillion in equity evaporated, although the market regained 70% by the end of the day.

Initial reports claimed that the crash was caused by a mistyped order that proved to be erroneous. The flash was attributed to Navinder Singh Sarao, a futures trader in the London suburbs, who pled guilty for attempting to spoof the market by quickly buying and selling hundreds of E-Mini S&P Futures contracts through the CME.

Other Flash Crashes

There have been other recent events resembling flash crashes, wherein the volume of computer-generated orders outpaced the ability of the exchanges to maintain proper order flow. These include:  

  • Aug. 22, 2013: Trading was halted at the Nasdaq for more than three hours when computers at the NYSE could not process pricing information from the Nasdaq.
  • May 18, 2012: While not a flash crash per se, Meta (formerly Facebook) shares were held up for more than 30 minutes at the opening bell as a glitch prevented the Nasdaq from accurately pricing shares during its initial public offering (IPO), causing a reported $500 million in losses.

What Caused the Flash Crash of 2010?

According to an investigative report by the SEC, the Flash Crash of 2010 was triggered by a single order selling a large amount of E-Mini S&P contracts.

Can a Flash Crash Happen Again?

Even though there are measures put in place by exchanges to prevent them from taking place, flash crashes can and still do happen. According to two math professors at the University of Michigan at Ann Arbor, the stock market has approximately 12 mini flash crashes a day.

What Is a Flash Crash in the Stock Market?

A stock market flash crash refers to rapid price declines in an overall market or a stock's price due to a withdrawal of orders. Prices then rebound back to roughly the same level they were before the crash, almost as though it never took place.

How Long Does a Flash Crash Last?

A flash crash takes place within a single trading day and can last anywhere from a matter of minutes to a few hours.

Article Sources
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  1. Corporate Finance Institute. "Flash Crashes."

  2. U.S. Securities and Exchange Commission. "Findings Regarding The Market Events of May 6, 2010," Page 1.

  3. Investor, U.S. Securities and Exchange Commission. "Stock Market Circuit Breakers."

  4. U.S. Securities and Exchange Commission. "SEC Adopts New Rule Preventing Unfiltered Market Access."

  5. Reuters. "UK Speed Trader Arrested Over Role in 2010 'Flash Crash'."

  6. Bloomberg. "Guy Trading at Home Caused the Flash Crash."

  7. Nasdaq. "Nasdaq OMX Provides Updates on Events of August 22, 2013."

  8. TechCrunch. "NASDAQ’s Glitch Cost Facebook Investors ~$500M. It Will Pay Out Just $62M. IPO Elsewhere."

  9. U.S. Securities and Exchange Commission. "Findings Regarding the Market Events of May 6, 2010," Pages 1-2.

  10. MarketWatch. "Opinion: The Stock Market has About 12 Mini Flash Crashes a Day — and We Can’t Prevent Them."

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