SEC-CFTC Find Flash-Crash Smoking Gun

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After months of waiting for the US Securities and Exchange Commission (SEC) and the US Commodity Futures Trading Commission (CFTC) to release their joint report on the May 6 Flash Crash that roiled the US futures and equities markets, the world now knows the face of evil behind the crash—a volume-oriented sell algorithm that was trying to unload 75,000 e-mini contracts in the space of 20 minutes without regard to price or time.

Quiet honestly, I was disappointed to learn that the regulators were able to trace the source of the crash to a single trade. Mind you, I'm impressed that they have the ability to sift through such a huge amount of data to pinpoint the origin of the crisis. But as a former historian-in-training, I was hoping that it would have come down to such a confluence of events that academics would be chewing on it for decades to come, like the myriad factors that led to the Great Depression of the 1930s, rather than the cut-and-dried incident that sparked World War I.

The report provides good moment-by-moment coverage of the event, but it will be interesting to see how the regulators use this knowledge to prevent similar events from happening in the future.

A couple of positive takeaways from the report include improving the transparency on how regulators like Financial Industry Regulatory Authority (Finra) will break erroneous trades in the future, as well as setting up upper and lower limits around a trading price where traders know that a trade would be erroneous. The latter should keep actual trades from colliding with resting stub quotes on the book.

The most important lesson learned is that without having specialists acting as a market of last resort, tasked with providing "fair and orderly markets," the industry will have to get used to circuit breakers being tripped. The Flash Crash demonstrates that while high-frequency traders provide the lion's share of liquidity—along with a number of liquidity providers—there is nothing stopping them from stepping back from trading and accelerating a downward market.

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