"On May 6, 2010, the prices of many U.S.-based equity products experienced an extraordinarily rapid decline and recovery. That afternoon, major equity indices in both the futures and securities markets, each already down over 4% from their prior-day close, suddenly plummeted a further 5-6% in a matter of minutes before rebounding almost as quickly. Many of the almost 8,000 individual equity securities and exchange traded funds (“ETFs”) traded that day suffered similar price declines and reversals within a short period of time, falling 5%, 10% or even 15% before recovering most, if not all, of their losses. However, some equities experienced even more severe price moves, both up and down. Over 20,000 trades across more than 300 securities were executed at prices more than 60% away from their values just moments before. Moreover, many of these trades were executed at prices of a penny or less, or as high as $100,000, before prices of those securities returned to their “pre-crash” levels. By the end of the day, major futures and equities indices “recovered” to close at losses of about 3% from the prior day."
- Findings Regarding the Market Events of May 6, 2010, Report of the Staffs of the SEC and the CFTC to the Joint Advisory Committee on Emerging Regulatory Issues
This severe volatility in equities that occurred on May 6, 2010 has come to be known as a FLASH CRASH. As shown in this diagram from the New York Times, a sudden sale of equities occurred rapidly and in part spurred by automated trading. This flash crash resulted in extreme volatility in stock prices spurred by selling in futures markets which than spilled over to sell offs in stock markets. The "interconnectedness" of markets combined with the rapid speed at which transactions occur both contribute to the flash crash phenomenon.
Some articles from the popular press that explain the dynamic behind the Flash Crash:
- Breakdown, A Glimpse Inside the "Flash Crash" from the Wall Street Journal, June 10, 2012.
- One Big, Bad Trade from the Economist, October 1, 2010.
- Why We Could Easily Have Another Flash Crash, from Forbes Online, August 9, 2013
One solution explored to avoid flash crashes is continued monitoring of real time data to by regulators. As explained by the SEC on the MIDAS database website :
"Most investors are familiar with the ticker that crawls across TV screens on business channels. It’s based on the consolidated tape that generally includes every trade of 100 shares or more in listed equities, such as corporate stocks and exchange-traded products.
But the consolidated tape does not provide a complete picture. First, for all but a few equities, trades of less than 100 shares are not currently reported. Second, though the tape does provide data on the price and size of the best bid and best offer for each stock on each exchange, it does not provide information on orders placed below the best bid or above the best offer."
MIDAS collects data that "most institutional investors, retail investors, and academics, generally do not consume" because "it is extremely voluminous, challenging to process correctly, and requires specialized data expertise."
How does all this data help prevent or better monitor flash crashes? One advantage is the SEC can better understand transactions that occur in milliseconds, for example, as illustrated in this chart: