Flash Crash – the most dreaded event !!!

Flash crashFlash Crash is an event that occurred on 6th May 2010 for the very first time in the US markets. The event was marked by a sudden and steep drop of around 10% of the index; and that too with unknown reasons. The equity markets were quick to shed around 1000 points within a short span of about four minutes and were quick enough to regain the loses in the next twenty minutes; with the whole event unsupported by any reason/cause.

As was stated later by few reporters/investigating teams that the markets began to lose when a huge sell order was placed by a firm initially and the High Frequency Traders (HFT) carried the wave forward. HFT are traders that do specialise in quick trading in the markets and hardly hold any positions for long time. These HFT(s) began selling their acquired positions in huge number. This created a huge selling pressure contributed by trading algorithm, HFT and common traders who followed the suit and resulted into steep loss. The investigation teams coined the word “flash crash” for the event.

Since then, India too has witnessed such flash crash several times where a wrong order entry initiated a crash. In FY13 itself NSE has witnessed three of such events with the recent one dated back to 5th October 2012 making the bourse to lose 15.5% in couple of minutes itself.

Eventhough the regulator is keeping a close watch to control such events but the question remains is whether such efforts are sufficient enough or not.

Suggested actions to be taken:

Few preliminary reports quoted that a wrongly entered trade by a big trading firm (or sell algorithm) initiates such loss which is then carried by HFT and other traders. In order to control such events in future some of the steps that could be taken include:

  1. The bourses should implement individual stock triggers so as to freeze trading on them as soon the individual triggers are reached in place of a combined trigger for the index.
  2. The trading range for the stocks should be narrowed from it’s present form. Currently the traders can place orders for any stock withing a range of +/- 20% from the previous day’s closing price. This should be reduced significantly so that wrong trades and the trades which could affect the prices significantly could be reduced.
  3. The Indian markets lack sufficient depth at present. As the recent crash that occurred on 5th October 2012 was simply because transactions of around Rs. 650 crores made the entire buy-side vanish away. This sorry state of affair has resulted since the finance ministry has imposed STT on the markets which reduced the amount of trading and investments into the markets. Thus sufficient steps should be taken so as to regain interest and reliability of the markets.
  4. Not even this but every trader should be allocated with a certain trading limits so that the primary cause of entering wrong trades on the side of the trader itself is eliminated.
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