This weekend marks the two-year anniversary of the aptly named flash crash. On May 6, 2010, starting at 2:42 in the afternoon, the Dow Jones Industrial Average plummeted nearly 600 points in just five minutes, only to recover most of that loss two minutes later. A few large U.S. companies witnessed their stocks trading for as little as a penny a share before snapping back to near where they had been trading when the day began. What would be the second-biggest trading day for U.S. equity markets — 19.3 billion shares crossed the tape — left investors, regulators and most journalists scratching their heads. At the time, I was wrapping up five months of reporting for a feature on high frequency trading, which some market pundits initially blamed for causing the flash crash. High frequency traders — firms that deploy sophisticated computer algorithms to buy and sell securities in tiny fractions of a second, using proprietary capital — were later vindicated in an 87-page report by the staffs of the Commodity Futures Trading Commission and the Securities and Exchange Commission, which traced the cause to a large order by a mutual fund company to sell futures contracts tied to the Standard & Poor’s 500 index.
The SEC, for its part, reacted quickly, adopting new circuit-breaker rules in June 2010 that pause trading for five minutes in shares of S&P 500 stocks whose prices move 10 percent or more — up or down — in a five-minute period. A somewhat crude solution, the circuit breakers, which were later extended to all U.S. equities and exchange-traded funds, have been effective in helping to prevent a repeat of the events of May 6.
On the first anniversary of the flash crash, SEC chairman Mary Schapiro told a packed room of investment managers and financial advisers at a conference in Washington that the commission had a plan to deal with “extreme price moves” and “excessive volatility.” One of the key pieces of the volatility plan is a proposed “limit up/limit down” mechanism that would replace the single-stock circuit breakers. The new rule would create price-limit bands of 5, 10 or 20 percent, depending on the stock and the time of day it is trading. Stocks that move outside the price band would have to take a time-out: a five-minute pause in trading to let investors clear their heads and assess whether the abrupt move that triggered the mechanism was justified.
The SEC commissioners are expected to vote on the limit up/limit down mechanism soon. At the same time, they are going to consider a proposal to change the marketwide circuit-breaker rules — originally put in place after the 1987 crash — reducing the thresholds that would trigger a trading halt and shortening its duration. Although an SEC spokesman wouldn’t comment on the upcoming votes, the fact that the commission staff has been pushing hard for the changes is encouraging.
Regardless of the outcome, one thing is clear: It’s less exciting, and profitable, to be a high frequency trader since the flash crash. U.S. equity-trading volumes are down substantially since then, averaging less than 7 billion shares a day this year, and they’re unlikely to increase without more improvement in the economy.
