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New regulations put in place following the 2010 flash crash<ref name="wsj_dec_2015">{{cite web | url=https://www.wsj.com/articles/should-you-fear-the-etf-1449457201 | title=Should You Fear the ETF? ETFs are scaring regulators and investors: Here are the dangers—real and perceived | publisher=Wall Street Journal | date=December 6, 2015 | access-date=December 7, 2015 | author=Weinberg, Ari I.}}</ref> proved to be inadequate to protect investors in the August 24, 2015, flash crash — "when the price of many ETFs appeared to come unhinged from their underlying value"<ref name="wsj_dec_2015" /> — and ETFs were subsequently put under greater scrutiny by regulators and investors.<ref name="wsj_dec_2015" />
On April 21, 2015, nearly five years after the incident, the U.S. Department of Justice laid
The [[Commodity Futures Trading Commission]] (CFTC) investigation concluded that Sarao "was at least significantly responsible for the order imbalances" in the derivatives market which affected stock markets and exacerbated the flash crash.<ref name="Bloomberg_2015">{{citation |work=Bloomberg News |title=How a Mystery Trader with an Algorithm May Have Caused the Flash Crash |url=https://www.bloomberg.com/news/articles/2015-04-22/mystery-trader-armed-with-algorithms-rewrites-flash-crash-story |access-date=April 25, 2015 |first1=Silla |last1=Brush |first2=Tom |last2= Schoenberg |first3=Suzi |last3=Ring |date=April 22, 2015}}</ref> Sarao began his alleged market manipulation in 2009 with commercially available trading software whose code he modified "so he could rapidly place and cancel orders automatically".<ref name="Bloomberg_2015" /> ''Traders Magazine'' journalist, John Bates, argued that blaming a 36-year-old small-time trader who worked from his parents' modest stucco house in suburban west London<ref name="Bloomberg_2015" /> for sparking a trillion-dollar stock market crash is "a little bit like blaming lightning for starting a fire" and that the investigation was lengthened because regulators used "bicycles to try and catch Ferraris". Furthermore, he concluded that by April 2015, traders can still manipulate and impact markets in spite of regulators and banks' new, improved monitoring of automated trade systems.<ref name="Traders_Magazine_2015">{{citation |title=Post Flash Crash, Regulators Still Use Bicycles To Catch Ferraris: Blaming the Flash Crash on a UK man who lives with his parents is like blaming lightning for starting a fire |work=Traders Magazine Online News |date=April 24, 2015 |access-date=April 25, 2014 |first=John |last=Bates |url=http://www.tradersmagazine.com/news/technology/post-flash-crash-regulators-still-use-bicycles-to-catch-ferraris-113762-1.html?ET=tradersmagazine%3Ae4256762%3A1181926a%3A&st=email |archive-url=https://web.archive.org/web/20180125134559/http://www.tradersmagazine.com/news/technology/post-flash-crash-regulators-still-use-bicycles-to-catch-ferraris-113762-1.html?ET=tradersmagazine%3Ae4256762%3A1181926a%3A&st=email |archive-date=January 25, 2018 |url-status=dead }}</ref>
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==Background==
On May 6, 2010, U.S. stock markets opened and the Dow was down, and trended that way for most of the day on worries about the [[European debt crisis|debt crisis in Greece]]. At 2:42 p.m., with the Dow down more than 300 points for the day, the equity market began to fall rapidly, dropping an additional 600 points in 5 minutes for a loss of nearly 1,000 points for the day by 2:47 p.m. Twenty minutes later, by 3:07 p.m., the market had regained most of the 600-point drop.<ref>{{Cite news|title=Market Plunge Baffles Wall Street—Trading Glitch Suspected in 'Mayhem' as Dow Falls Nearly 1,000, Then Bounces|last=Lauricella|first=Tom|work=The Wall Street Journal|date=May 7, 2010}}</ref>{{rp|1}} At the time of the flash crash, in May 2010, [[High-frequency trading|high-frequency traders]] were taking advantage of unintended consequences of the consolidation of the U.S. [[financial regulation]]s into [[Regulation NMS]],<ref name="Traders_Magazine_2015" /><ref>{{cite web|url=https://www.sec.gov/rules/proposed/34-50870.htm|title=Proposed Rule: Regulation NMS; Release No. 34-50870; File No. S7-10-04|work=sec.gov|access-date=August 22, 2015}}</ref> designed to modernize and strengthen the United States [[National Market System]] for [[equity securities]].<ref>Joel Seligman, Rethinking Securities Markets, The Business Lawyer, Vol. 57, Feb. 2002</ref>{{rp|641}} The Reg NMS, promulgated and described by the [[United States Securities and Exchange Commission]], was intended to assure that investors received the best price executions for their orders by encouraging competition in the marketplace, created attractive new opportunities for high-frequency-traders. Activities such as [[Spoofing (finance)|spoofing]], [[Layering (finance)|layering]] and [[front running]] were banned by 2015.<ref>{{Cite web|date=2013-07-22|title=CFTC Fines Algorithmic Trader $2.8 Million For Spoofing In The First Market Abuse Case Brought By Dodd-Frank Act, And Imposes Ban {{!}} Finance Magnates|url=https://www.financemagnates.com/forex/regulation/cftc-fines-algorithmic-trader-2-8-million-for-spoofing-in-the-first-market-abuse-case-brought-by-dodd-frank-act/|access-date=2021-02-03|website=Finance Magnates {{!}} Financial and business news|language=en}}</ref> This rule was designed to give investors the best possible price when dealing in stocks, even if that price was not on the exchange that received the order.<ref>{{cite journal |last1=Stoll |first1=Hans R. |title=Electronic Trading in Stock Markets |journal=Journal of Economic Perspectives |date=2006 |volume=20 |issue=1 |pages=153–174 |doi=10.1257/089533006776526067|s2cid=154982529 |url=http://www.aeaweb.org/articles.php?doi=10.1257/089533006776526067 |doi-access=free }}</ref>{{rp|171}}
==Explanation==
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Several plausible theories were put forward to explain the plunge.
#'''The fat-finger theory:''' In 2010 immediately after the plunge, several reports indicated that the event may have been triggered by a [[Fat-finger error|fat-finger trade]], an inadvertent large "sell order" for [[Procter & Gamble]] stock, inciting massive [[algorithmic trading]] orders to dump the stock; however, this theory was quickly disproved after it was determined that Procter and Gamble's decline occurred after a significant decline in the E-Mini S&P 500 futures contracts.<ref>{{cite web|url=http://opinion.financialpost.com/2010/05/07/pg-error-started-rout-but-money-managers-expect-slow-but-upwards-equity-markets-to-continue/|title=P&G error started rout but money managers expect "slow but upwards equity markets to continue" - Financial Post|author=Jonathan Chevreau|date=May 7, 2010|work=Financial Post|access-date=May 8, 2010|archive-url=https://web.archive.org/web/20100508205951/http://opinion.financialpost.com/2010/05/07/pg-error-started-rout-but-money-managers-expect-slow-but-upwards-equity-markets-to-continue/|archive-date=May 8, 2010|url-status=dead}}</ref><ref>{{cite news|url=http://www.suntimes.com/business/roeder/2250624,CST-NWS-curious09.article|title=Chicago Sun-Times – Chicago : News : Politics : Things To Do : Sports|work=Chicago|access-date=August 22, 2015|archive-url=https://web.archive.org/web/20100620132455/http://www.suntimes.com/business/roeder/2250624,CST-NWS-curious09.article|archive-date=June 20, 2010|url-status=dead}}</ref><ref>{{cite news|url=https://blogs.wsj.com/marketbeat/2010/05/20/secs-schapiro-heres-my-timeline-of-the-flash-crash |work=The Wall Street Journal |title=SEC's Schapiro: Here's My Timeline of the Flash Crash |first=Matt |last=Phillips |date=May 20, 2010 |access-date=May 30, 2010 |archive-url=https://web.archive.org/web/20100618025357/https://blogs.wsj.com/marketbeat/2010/05/20/secs-schapiro-heres-my-timeline-of-the-flash-crash |archive-date=June 18, 2010 |url-status=live |df=mdy }}</ref> The "fat-finger trade" hypothesis was also disproved when it was determined that existing [[CME Group]] and ICE safeguards would have prevented such an error.<ref>{{cite web|url=http://www.commodityonline.com/news/What-went-wrong-with-US-futures-on-Thursday-28089-2-1.html |title=What went wrong with US futures on Thursday? : Detailed News | 12 May 2010 |publisher=commodityonline.com |access-date=October 1, 2010}}</ref>
#'''Impact of high frequency traders:''' Regulators found that [[High-frequency trading|high frequency traders]] exacerbated price declines. Regulators determined that high frequency traders sold aggressively to eliminate their positions and withdrew from the markets in the face of uncertainty.<ref name=WSJ1 /><ref name=bloomberg1 /><ref name=NYT1 /><ref name=reuters1 /> A July 2011 report by the [[International Organization of Securities Commissions]] (IOSCO), an international body of securities regulators, concluded that while "algorithms and HFT technology have been used by market participants to manage their trading and risk, their usage was also clearly a contributing factor".<ref name="iosco">{{Citation|author=Technical Committee of the International Organization of Securities Commissions|title=Regulatory Issues Raised by the Impact of Technological Changes on Market Integrity and Efficiency | url=http://www.iosco.org/library/pubdocs/pdf/IOSCOPD354.pdf | work=[[IOSCO Technical Committee]] |date=July 2011|access-date=July 12, 2011}}</ref><ref name="reutersiosco">{{cite news |author=Huw Jones |title=Ultra fast trading needs curbs -global regulators | url=http://uk.reuters.com/article/regulation-trading-idUKN1E7661BX20110707 | archive-url=https://web.archive.org/web/20160128152958/http://uk.reuters.com/article/regulation-trading-idUKN1E7661BX20110707 | url-status=dead | archive-date=January 28, 2016 |work=Reuters |date=July 7, 2011|access-date=July 12, 2011}}</ref> Other theories postulate that the actions of high frequency traders (HFTs) were the underlying cause of the flash crash. One hypothesis, based on the analysis of bid–ask data by [[Nanex]], LLC, is that HFTs send non-executable orders (orders that are outside the [[bid–ask spread]]) to exchanges in batches. Though the purpose of these orders is not publicly known, some experts speculate that their purpose is to increase noise, clog exchanges, and outwit competitors.<ref name=nytimesAug22/> However, other experts believe that deliberate [[market manipulation]] is unlikely because there is no practical way in which the HFTs can profit from these orders, and it is more likely that these orders are designed to test latency times and to detect early price trends.<ref name=robotpatterns>{{Cite news|publisher=The Atlantic |title=Explaining Bizarre Robot Stock Trader Behavior |last=Madrigal |first=Alexis |date=August 6, 2010 |url=https://www.theatlantic.com/science/archive/2010/08/explaining-bizarre-robot-stock-trader-behavior/61028/ |access-date=August 26, 2010 |archive-url=https://web.archive.org/web/20100817012139/http://www.theatlantic.com/science/archive/2010/08/explaining-bizarre-robot-stock-trader-behavior/61028/ |archive-date=August 17, 2010 |url-status=live |df=mdy }}</ref> Whatever the reasons behind the existence of these orders, this theory postulates that they exacerbated the crash by overloading the exchanges on May 6.<ref name=nytimesAug22/><ref name=robotpatterns/> On September 3, 2010, the regulators probing the crash concluded: "that [[quote stuffing|quote-stuffing]]—placing and then almost immediately cancelling large numbers of rapid-fire orders to buy or sell stocks—was not a 'major factor' in the turmoil".<ref name="ft">{{Cite news|work=Financial Times |title=Flash crash probe plays down quote-stuffing |date=September 4, 2010 |url=http://www.ft.com/cms/s/0/c673e6ee-b6e9-11df-b3dd-00144feabdc0.html |access-date=September 4, 2010 |archive-url=https://web.archive.org/web/20100904072041/http://www.ft.com/cms/s/0/c673e6ee-b6e9-11df-b3dd-00144feabdc0.html |archive-date=September 4, 2010 |url-status=live |df=mdy }}</ref> Some have put forth the theory that high-frequency trading was actually a major factor in minimizing and reversing the flash crash.<ref name="wsjflashcrash">Michael Corkery, ''[[The Wall Street Journal]]'', September 13, 2010, [https://blogs.wsj.com/deals/2010/09/13/jim-simons-on-flash-crash-high-frequency-traders-saved-the-day/?goback=.gde_86999_member_29971040 High Frequency Traders Saved the Day]</ref>
#'''Large directional bets:''' Regulators said a large [[E-Mini]] S&P 500 seller set off a chain of events triggering the Flash Crash, but did not identify the firm.<ref name=WSJ1 /><ref name=bloomberg1>{{Cite news|title=Automatic Futures Trade Drove May Stock Crash, Report Says |last=Mehta |first=Nina |publisher=Bloomberg |date=October 1, 2010 |url=https://www.bloomberg.com/news/2010-10-01/automatic-trade-of-futures-drove-may-6-stock-crash-report-says.html |access-date=October 29, 2010 |archive-url=https://web.archive.org/web/20101004094224/http://www.bloomberg.com/news/2010-10-01/automatic-trade-of-futures-drove-may-6-stock-crash-report-says.html |archive-date=October 4, 2010 |url-status=live |df=mdy }}</ref><ref name=NYT1>{{Cite news|title=Lone $4.1 Billion Sale Led to 'Flash Crash' in May|last=Bowley|first=Graham|work=The New York Times|date=Oct 1, 2010|url=https://www.nytimes.com/2010/10/02/business/02flash.html?_r=1&scp=1&sq=flash+crash&st=nyt| access-date= October 28, 2010 }}</ref><ref name=reuters1>{{Cite news|title=Single U.S. trade helped spark May's flash crash|last=Spicer|first=Jonathan|publisher=Reuters|date=Oct 1, 2010|url=https://www.reuters.com/article/idUKN0114164220101001| access-date= October 29, 2010 }}</ref> Earlier, some investigators suggested that a large purchase of [[put option]]s on the [[S&P 500|S&P 500 index]] by the [[hedge fund]] [[Universa Investments]] shortly before the crash may have been among the primary causes.<ref>[https://www.wsj.com/articles/SB10001424052748704879704575236771699461084 Did a Big Bet Help Trigger 'Black Swan' Stock Swoon?], Wall Street Journal, May 11, 2010</ref><ref>[https://blogs.forbes.com/streettalk/2010/05/07/was-the-market-mayhem-a-mistake-maybe-not/ Was The Market Mayhem A Mistake? Maybe Not.], Liz Moyer, Forbes.com</ref> Other reports have speculated that the event may have been triggered by a single sale of 75,000 E-Mini S&P 500 contracts valued at around $4 billion by the [[Overland Park, Kansas]], firm [[Waddell & Reed]] on the [[Chicago Mercantile Exchange]].<ref>{{cite news|url=https://www.huffingtonpost.com/2010/10/01/flash-crash-report-one-41_n_747215.html|title='Flash Crash' Report: Waddell & Reed's $4.1 Billion Trade Blamed For Market Plunge|work=The Huffington Post | date=October 1, 2010}}</ref> Others suspect a movement in the U.S. Dollar to [[Japanese yen]] exchange rate.<ref>[http://seekingalpha.com/article/203603-the-yen-did-it?source=hp_wc The Yen Did It?], by Bruce Krasting, seekingalpha.com</ref>
#'''Changes in market structure:''' Some market structure experts speculate that, whatever the underlying causes, equity markets are vulnerable to these sort of events because of decentralization of trading.<ref name=nytimesAug22>{{Cite news|title=Stock Swing Still Baffles, Ominously|last=Bowley|first=Graham|work=The New York Times|date=August 22, 2010}}</ref>
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===SEC/CFTC report===
On September 30, 2010, after almost five months of investigations led by Gregg E. Berman,<ref>{{cite web |title=Ex-Physicist Leads Flash Crash Inquiry (Published 2010) |website=[[The New York Times]] |archive-url=https://web.archive.org/web/20230610235625/https://www.nytimes.com/2010/09/21/business/economy/21flash.html
The joint 2010 report "portrayed a market so fragmented and fragile that a single large trade could send stocks into a sudden spiral",<ref name=WSJ1>{{Cite news|title=How a Trading Algorithm Went Awry |last=Lauricella |first=Tom |work=The Wall Street Journal |date=October 2, 2010 |url=https://www.wsj.com/articles/SB10001424052748704029304575526390131916792 |access-date=October 28, 2010 |archive-url=https://web.archive.org/web/20101021141951/http://online.wsj.com/article/SB10001424052748704029304575526390131916792.html |archive-date=October 21, 2010 |url-status=live |df=mdy }}</ref> and detailed how a large [[mutual fund]] firm selling an unusually large number of [[E-Mini S&P]] contracts first exhausted available buyers, and then how [[High-frequency trading|high-frequency traders]] (HFT) started aggressively selling, accelerating the effect of the mutual fund's selling and contributing to the sharp price declines that day.<ref>'''Sources''':
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[[File:Flash Crash.jpg|thumb|"Order flow toxicity" (measured as CDF [VPIN]) was at historically high levels one hour prior to the ''flash crash'']]
{{external media
|
| width = 225px
| video1 = [https://www.youtube.com/watch?v=IngpJ18AhWU Video of the S&P500 futures during the flash crash]<!---This was posted on YouTube by the copyright holder, therefore it is permissible under [[WP:YOUTUBE]]--->
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===Evidence of market manipulation and arrest===<!-- [[Navinder Singh Sarao]] redirects here -->
In April 2015, Navinder Singh Sarao, an [[autistic]]<ref>{{Cite news|url=https://www.thetimes.co.uk/article/navinder-singh-sarao-the-flash-crash-trader-who-fell-foul-of-washington-3vl5vvcbj|title = Navinder Singh Sarao: The 'flash crash' trader who fell foul of Washington|last1 = Vaughan|first1 = Liam}}</ref><ref>{{Cite web|url=https://abcnews.go.com/US/wireStory/autistic-futures-trader-triggered-crash-spared-prison-68599310|title = Autistic futures trader who triggered crash spared prison|website = [[ABC News (United States)|ABC News]]}}</ref> London-based point-and-click trader,<ref>{{cite news |title=The trader blamed for the 'flash crash' tried to blow the whistle on other traders|date=May 15, 2015|access-date=Dec 30, 2015|publisher=[[Business Insider Australia]]|url=
*{{cite news | url=https://www.nytimes.com/2015/08/15/business/dealbook/bail-reduced-for-british-trader-charged-in-flash-crash.html | title=British Trader Charged in 'Flash Crash' Released After Bail Reduction | publisher=DealBook | date=August 14, 2015 | access-date=August 17, 2015 | author=Bray, Chad}}
*{{cite web |last1=Lynch |first1=Sarah N. |last2=Polansek |first2=Tom |last3=Miedema |first3=Douwe |title=Documents show flash crash trader's frenetic business dealings |url=https://www.reuters.com/article/us-flashcrash-trader-rjobrien/documents-show-flash-crash-traders-frenetic-business-dealings-idUSKBN0NE27820150424?feedType=RSS&feedName=topNews |publisher=Reuters |date=April 23, 2015}}
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In a 2011 article that appeared on the ''Wall Street Journal'' on the eve of the anniversary of the 2010 "flash crash", it was reported that high-frequency traders were then less active in the stock market. Another article in the journal said trades by high-frequency traders had decreased to 53% of stock-market trading volume, from 61% in 2009.<ref name=WSJminicrash>{{cite news|url=https://www.wsj.com/articles/SB10001424052748704322804576303522623515478 |title=Mini 'Crashes' Hit Commodity Trade |date=May 5, 2011 |author1=Carolyn Cui |author2=Tom Lauricella |work=The Wall Street Journal | access-date= May 7, 2011 }}</ref> Former Delaware senator [[Ted Kaufman|Edward E. Kaufman]] and Michigan senator [[Carl Levin]] published a 2011 op-ed in ''[[The New York Times]]'' a year after the Flash Crash, sharply critical of what they perceived to be the SEC's apparent lack of action to prevent a recurrence.<ref name=KaufmanLevin>{{cite news|url=https://www.nytimes.com/2011/05/06/opinion/06kaufman.html|title=Preventing the Next Flash Crash |date=May 6, 2011 |author1=Edward E. Kaufman |author2=Carl Levin |work=The New York Times | access-date= July 13, 2011 }}</ref>
In 2011 high-frequency traders moved away from the stock market as there had been lower [[volatility (finance)|volatility]] and volume. The combined average daily trading volume in the New York Stock Exchange and Nasdaq Stock Market in the first four months of 2011 fell 15% from 2010, to an average of 6.3 billion shares a day. Trading activities declined throughout 2011, with April's daily average of 5.8 billion shares marking the lowest month since May 2008. Sharp movements in stock prices, which were frequent during the period from 2008 to the first half of 2010, were in a decline in the Chicago Board Options Exchange volatility index, the VIX, which fell to its lowest level in April 2011 since July 2007.<ref name=WSJ110505/>
These volumes of trading activity in 2011, to some degree, were regarded as more natural levels than during the financial crisis and its aftermath. Some argued that those lofty levels of trading activity were never an accurate picture of demand among investors. It was a reflection of computer-driven traders passing securities back and forth between day-trading hedge funds. The flash crash exposed this phantom liquidity. In 2011 high-frequency trading firms became increasingly active in markets like futures and currencies, where volatility remains high.<ref name=WSJ110505>{{cite news|url=https://www.wsj.com/articles/SB10001424052748704322804576303543741007746 |title=Traders Exit High-Speed Lane |date=May 5, 2011 |author=Tom Lauricella |work=The Wall Street Journal | access-date= May 7, 2011 }}</ref>
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{{Subprime mortgage crisis}}
[[Category:2010 in
[[Category:2010 in the United States|Flash crash]]
[[Category:Great Recession in the United States]]
[[Category:Stock market crashes]]
[[Category:2010s in economic history|Flash crash]]
[[Category:Algorithmic trading]]
[[Category:May 2010 events in the United States|Flash crash]]
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