Category: 

What is a Flash Crash?

Article Details
  • Written By: Mary McMahon
  • Edited By: Kristen Osborne
  • Last Modified Date: 06 October 2018
  • Copyright Protected:
    2003-2018
    Conjecture Corporation
  • Print this Article

A flash crash is a sudden and very rapid decline in value for a stock market, followed by a recovery of much of the loss within minutes. A notable example occurred on 6 May 2010, when the Dow Jones Industrial Average lost 600 points in the afternoon, and almost immediately regained the loss. The causes of flash crashes are variable and in some cases impossible to determine, but they tend to occur more frequently in periods of economic uncertainty, when trading is volatile and investors are nervous.

In the case of the Flash Crash of 2010, as it is sometimes known, a number of theories were put forward to explain the incident, and an investigation was launched to determine whether illegal or ethically dubious trading activities contributed. Some theorists suggested the crash could be attributed to a flood of trades processed at the same time, triggering a response from automated trading systems trying to keep up. Others claimed it was the fault of a glitch triggering a large sell order and setting off a cascade of orders by other traders in response.

Ad

High volume trading is also pointed to as a contributing factor in flash crashes. Traders handling very large trades on a regular basis can contribute to shifts in market value and if multiple traders move in the same direction, it could potentially create investor panic, leading to a flash crash. As traders shift their positions again, the market should recover, although individual traders could potentially take big losses if they moved at the wrong time.

Another practice of interest in the analysis of a flash crash is quote stuffing, a technique used to distract other traders by creating what are essentially red herring trades. A buy or sell order is placed, left in place long enough to attract attention, and withdrawn. People make investment decisions on the basis of the order they see and by the time their trades go through, the order in question has vanished. Quote stuffing has been identified by some critics as a potentially fraudulent or questionable practice and might be considered market manipulation, since the goal is to push people into trading activities on the basis of false information.

However a flash crash is caused, it represents a temporary blip on the financial market. Flash crashes can occur in many different kinds of markets. The rapid recovery makes them easy to distinguish from more serious crashes, where the value of the market falls and does not rise again. As a market phenomenon, they are a topic of study among some economists interested in learning why markets sometimes recover rapidly after a precipitous fall in value, and at other times do not.

Ad

Recommended

Discuss this Article

Post your comments

Post Anonymously

Login

username
password
forgot password?

Register

username
password
confirm
email