The Flash Crash, 2010Needs one idea

A market that fell and recovered inside half an hour, with individual shares printing at a cent. Liquidity turned out to be a service somebody chooses to provide.

3 min read · 556 words

What happened

• 6 May 2010, afternoon — US equity indices fell steeply and recovered most of the fall within roughly twenty minutes.
• The prints — some individual shares and exchange-traded funds traded at prices far from any sensible value, including trades at a cent and, in a few names, at absurdly high levels. Many were later cancelled under the exchanges' erroneous-trade rules.
• The joint report — the US regulators published a report later in 2010 describing a large automated sell programme in index futures interacting with market conditions already thin that day.
• Afterwards — single-stock circuit breakers, and then the limit-up/limit-down regime, were introduced to pause trading in an instrument whose price moves too far too fast.

The mechanism

• Nobody is obliged to quote. Most electronic market makers provide liquidity because it is profitable, not because they must. When the risk of being run over rises, the rational response is to widen or step away — simultaneously, because everyone is reading the same conditions.
• A stub quote is not a price. Where an obligation to post something existed, it could be met with a token quote far from the market. Those quotes were never meant to trade, and on that afternoon some of them did.
• Market orders find whatever is there. A market order is an instruction to trade at the best available price, and "best available" was, for moments, a cent. This is the same mechanism described in why you did not get the price you saw, at its extreme.
• Stop orders became sellers. Stops triggered by the fall converted into market orders and sold into a book that had emptied, which pushed prices further and triggered more stops. The feedback is the event.
• Fragmentation matters. The same instrument trades in many venues. When one pauses and others do not, orders route to wherever is still open — which is not necessarily where the liquidity is.

What it teaches

• Liquidity is a behaviour, not a property. An instrument is not liquid; it is being made liquid by people who can stop. What liquidity costs is the general version.
• A stop is not a price guarantee. It is a trigger that produces a market order. On the worst day of the decade for a given instrument, that is exactly when the distinction bites.
• Circuit breakers are an admission. The rules built afterwards do not prevent falls; they insert pauses so that humans and slower systems can rejoin. That is a design choice about speed, and it says the machinery was faster than the market's ability to price.
• Cancelled trades are their own lesson. A trade that printed and was later voided is a reminder that "executed" is not final until the venue says so — a settlement-shaped question wearing a microstructure hat.

The mechanisms behind this

• Market microstructure — order books, quotes, and who is standing there.
• Liquidity — the property that is not a property.
• What happens when I press buy — routing and matching on an ordinary day.