The Flash Crash, Explained by Jacob Goldstein, Essay Example

In his article, “The Flash Crash, Explained”, Jacob Goldstein recounts the momentary crash in the stock market that took place in May 2010. Goldstein highlights the SEC report which came out late September 2010 that south to explain the reasons for the crash. However, he maintains his personal opinion on the crash highlighting the fact that it was not a computer glitch but rather trader sceptics that led to the drastic impacts the crash had on the stock market.

Goldstein looks at how the flash crash was caused by a single trader. A trader working for Waddell & Reed had executed an order that contained over 75,000 futures whose net worth was to the tune of $4.1 billion. All these futures contracts were pegged to the S&P 500. Goldstein explains how trades of such a magnitude usually take a couple of hours to be completed and that such trades usually require multiple buyers. This single trade is the one thing that would cause the market to temporarily crash that wold be aided by a compute algorithm as such voluminous trades employ a computer algorithm to execute.

The article mention of how on this day, the market was experiencing an unsteady trend fluctuating repeatedly. The computer algorithm that Waddell & Reed on this particular trade did not incorporate and take into account the important factor of price. The price begun to sharply fall as the sale of this trade, the futures contracts, progressed. With the prices plunging drastically, other traders were forced to sell actual stock funds and stocks. This instigated the market plunge.

The article explains how many big traders opted to momentarily step out of the market in order to assess the market situation. By virtue of having very few traders in the markets, prices fell further triggering a market circuit breaker to temporarily halt the trading of futures contracts. This is what helped break the cycle and bring the market to stability.With the market recovering, some high value stocks were being sold at very low prices. Regulators of the SEC reversed these trades, citing and error in the trades.

The article shows how after this experience, the SEC begun to set up policies and structures to prevent such an event occurring again. The SEC made alterations to their computer programs to temporarily stop trading if an individual stocks value increases or decreases by 10% within a short time period, 5 minutes. Also, they stipulated regulations that governed the perception of a trade as erroneous.

Goldstein gives his personal opinion after talking to an NYU Stern School finance professor, Robert Whitelaw. According to Whitelaw, none of the trades that were reversed by the SEC were erroneous. He maintains that those trades were valid and the reason why these prices were so low was because traders left trade orders that they did not expect to be successful, even though they were. Whitelaw argued that the stock market is naturally volatile and risky, as such, adding new rules would only create the illusion that the stock market is safe and loss fool proof, while this is not the case. Such events are critical in helping traders understand the market more and predict underlying trends.

Response

It seems that the stock market is not as safe as the SEC had initially perceived it to be. Clearly a single trade can still bring down the entire stock market by affecting the prices of stocks or futures contracts. It is essential to understand that the market is responsive to the volume of trades. These large trades are what caused the initial change in the price of a given stock in the market. This is because the market is largely affected by the perception of traders. The traders in the SEC on May 2010 saw the decreasing price of stock, triggering a massive sell out and a sit out by the major traders. This only plays to confirm that the stock market in essence should remain an uncertain market free from over stringent regulations in order to allow for free movement of market forces.

The SEC’s decision to reverse the trades that they perceived as erroneous only plays to counter this fact. By reversing the trades, they deny the market traders the ability to understand, analyse and predict the movement of market forces to allow them to freely trade based on these forces.

I believe that the reversal of trades by the SEC is uncalled for and against the essence and foundations of the stock market. By leaving traders to execute trades against the market forces, the SEC would create the ideal environment for traders to exploit the market and bring it to its full potential. There are many unforeseen and unpredictable events that may occur in the stock market, it is up to the traders to decide when to execute trades. By adding new rules, it provides for the introduction of numerous new variables that will in the future provide an array of potential consequences to the market.