Flash Crash

Could there be another Flash Crash?

Bob Moon May 6, 2011
Flash Crash

Could there be another Flash Crash?

Bob Moon May 6, 2011

Bob Moon: A whole year has gone by, and they’re still trying to fix the problems that sent Wall Street on that gut-wrenching roller coaster ride they call the “Flash Crash.” The Dow plunged by more than 600 points in a matter of minutes, only to bounce back, an hour before the closing bell.

Closing bell ringing

Moon: Since then, regulators have imposed a few new rules aimed at limiting any wild trade swings. But many experts can’t rule out that something like the Flash Crash could happen again. So we’ve been checking to see if there’s anything the average investor might do to stay out of harm’s way.

Let’s start with a quick refresher on what federal regulators think happened that day: Most of the trading on Wall Street is now done with pre-programmed computers. And when a big mutual-fund decided to dump an unusually large “sell” order on the market, it triggered a wave of electronic trading.

Georgetown University finance professor James Angel explains it was already a turbulent trading day.

James Angel: Normally, the market could have handled an order that big, but the market was in just enough of a jittery moment that the big order caused prices to fall.

What we know as “Wall Street” is now spread so widely, across many different trading locations, that the tickers tracking all those prices couldn’t keep up. That, in turn, led to a sudden shortage of buyers, because professional traders checked out.

Angel: Their circuit-breakers went off and they said, “Whoa, something’s going wrong here. I don’t know if it’s my machine is bad or somebody else’s machine. I better not trade.” So the people who normally stabilize prices stepped to the sidelines, other people kept trading, and that’s where things went totally crazy.

Which brings us to the comparison I made here on Marketplace Money a year ago.

Sound of roulette wheel

If a roulette wheel goes haywire and the casino loses its marbles…

Sound of marble bouncing

…all bets are off.

But after the Flash Crash, the stock exchanges cancelled only some trades, limited to a seemingly arbitrary loss threshold. And burned stockholders complain there are still no promises that won’t happen again.

Rochelle Rittmaster: I feel like it’s been swept under the rug.

Rochelle Rittmaster lives near Denver. She had thousands of dollars in stock sold out from under her, when the Flash Crash triggered something called a “stop-loss order.” She wanted her shares sold if they fell below a certain value, but never imagined it could happen like this.

Rittmaster: What was really a bum deal was that my trade wasn’t reversed. Many others did have theirs reversed.

As James Angel at Georgetown sees it, blindly triggering the sale of your stock with a stop-loss order is always risky. He suggests long-term investors can learn a lesson from a shareholder who just stayed the course.

Angel: At the end of the day, the stock had almost fully recovered, and if you looked at the change in price from one day to the next, it wasn’t that big a deal. Unless you are trading at the very moment the glitch occurs, you’re not going to be affected by a temporary glitch.

Unless, that is, you’ve set up an automatic “sell” trigger. Rittmaster insists her stop-loss order made sense for her. And she complains the real problem is, a year’s gone by and investors still have to worry their money could be snatched away for no good reason.

Rittmaster: It doesn’t have to be anything fundamental. It doesn’t even have to be the emotions of the market for the day. It can merely be a bunch of algorithms started to be set off, and there you go.

Rittmaster has an ally in MIT finance professor Andrew Lo, who agrees that she and other innocent investors shouldn’t have suffered the losses they did from what was clearly a technical glitch. He says investors need to pressure their lawmakers in Washington to beef up consumer protections and their legal recourse against Wall Street.

Andrew Lo: You know, the large investors can deal with these kinds of glitches in various different ways, including legal remedies the small investor doesn’t have access to.

Ted Weisberg, at Seaport Securities, has been a broker on Wall Street almost 50 years. He’s also critical of government regulators for leaving out the little guy.

Ted Weisberg: The government basically keeps changing the rules to satisfy the professional trader, or the high-frequency trader, at the expense of the public.

The rush from human floor traders to ever-faster computers may have been well-intentioned, Weisberg says, but the Flash Crash is only one of the unintended consequences.

Weisberg: I think in general that speed kills, just like in automobiles. And I just think we need to slow things down a little bit. We need to give people a chance to be able to make decisions based on what’s going on around them. And all the systems in place today make it faster and faster and more confusing and more volatile.

But they’ve also made things easier in other ways, says MIT’s Andrew Lo.

Lo: Trading has never been cheaper, faster and more efficient for the typical investor. So individuals have really benefitted from this technology most of the time.

That’s small comfort for investors like Rochelle Rittmaster. Despite her losses in the Flash Crash — and her bitter distrust of Wall Street — her retirement money is still invested in the stock market.

Rittmaster: I am solely in it because it’s the only game in town. It reminds me of, there’s a Woody Allen joke in the movie “Annie Hall.” This guy says to his doctor…

Woody Allen as Alvy Singer: “My brother’s crazy, he thinks he’s a chicken.” And the doctor says, “Well, why don’t you turn him in?” And the guy says, “I would, but I need the eggs.”

Rittmaster: So I feel like I’m kind of in that situation — I still need the eggs.

Moon: For more on the Flash Crash, go to our Makin’ Money blog. Certified planner Ross Levin talks about the financial insight he received from his twins.

There’s a lot happening in the world.  Through it all, Marketplace is here for you. 

You rely on Marketplace to break down the world’s events and tell you how it affects you in a fact-based, approachable way. We rely on your financial support to keep making that possible. 

Your donation today powers the independent journalism that you rely on. For just $5/month, you can help sustain Marketplace so we can keep reporting on the things that matter to you.