Friday, May 7, 2010

Really scary: No one really knows why the market crashed and bounced yesterday

Excuses were made, rumors flew, stories were told, but the truth is no one really knows.

Some speculated it was a directed crash - and the options actions preceding the 5 minutes 700 points drop shows someone was building this. (so I've read, I don't know this to be fact at all)

The news correspondents told a weird story that a Proctor and Gamble trader mistakenly sold 15 Billion stocks instead of Million. Perhaps, I just didn't know a pharmaceuticals company has their own traders (or was it just bad linguistic - it was a person who traded the stock, not an employee of PG trading the market). Still, if it were only PG crashing... It definitely wasn't. Was it quants and robots? Hacked brokers computers?

The following story reaffirms that no one knows yet:
What the Heck Happened to the Stock Market Yesterday?
After yesterday's historic market plunge, everyone is groping for explanations. What caused the market to drop 999 points, mostly in the space of a half-hour, and then recover 700 points by the end of the day?

Was it the chaos in Europe, stock values that have overshot underlying economics, and other fundamentals? Or was it a "fat finger" trading error--the typing of "billion" instead of "million" in a sell order--and other glitches? Or was it the rise of computerized "high-frequency trading," which has taken humans out of the equation?

The answer right now is that no one knows for sure. The SEC has already launched an investigation, the NYSE and the NASDAQ are pointing fingers at one another, and firms are still digging through trading records.

But here's what we do know, says Mark Williams, finance professor at Boston University and the author of Uncontrolled Risk: Lessons of Lehman Brothers And How Systemic Risk Can Still Bring Down The World Financial System.

We know that there were some trading glitches, as evidenced by the NASDAQ cancelling trades in some stocks that had huge temporary moves. And we know that there is a very troubling economic backdrop to what happened, starting with the chaos in Europe.

Greece may be only the beginning of the European problems, Williams says. The issues there have yet to be solved, and they may soon spread to far larger countries like Spain. The market is absolutely right to be worried about this development, so a pullback in stocks is hardly surprising.

As for the role of "glitches" and electronics, we'll know more after the the investigations are concluded. But market crashes have happened throughout history, long before high-frequency trading and computerized execution came into being. They're rare, but they're also normal market behavior. So it's highly unlikely that the "cause" of yesterday's crash was some sort of electronic malfunction.

Madness to continue or end soon?

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