The CFTC’s and SEC’s report on what and who caused the flash crash is finally out and although we got a hint of what it would say this morning, and it didn’t sound too exciting, we’re still pumped to read it.We’ll essentially live-blog our reading of it, so keep checking back here for new information.
Here it is if you’d like to download it for yourself.
Here’s the intro, titled, “What happened?”
May 6 started as an unusually turbulent day for the markets. As discussed in more detail in the
Preliminary Report, trading in the U.S opened to unsettling political and economic news from
overseas concerning the European debt crisis. As a result, premiums rose for buying protection
against default by the Greek government on their sovereign debt. At about 1 p.m., the Euro
began a sharp decline against both the U.S Dollar and Japanese Yen.
Around 1:00 p.m., broadly negative market sentiment was already affecting an increase in the
price volatility of some individual securities. At that time, the number of volatility pauses,
also known as Liquidity Replenishment Points (“LRPs”), triggered on the New York Stock
Exchange (“NYSE”) in individual equities listed and traded on that exchange began to
substantially increase above average levels.
12:30 A couple minutes in and we’ve learned nothing new. That said, we’ve only read the “Executive Summary” and a few paragraphs of the “What happened?” sections. They’re just a summary of what anyone who’s been paying attention, either that day or any following, knows happened in chronological order.
12:35 We just searched the entire document for the name “Waddell and Reed.” As suspected because Reuters’ sources mentioned it last night, the firm which seems to have caused the Flash Crash with mini futures trades, is not mentioned.
12:39 We just skipped ahead to the section called “Market Participants.” The SEC says they interviewed firms that would, under normal conditions, provide liquidity. They found that nearly all of them (though not all of them) stopped trading and did not provide liquidity that day.
Funny sentence from that section in the document:
We note that even within the broad categories defined above, each firm has a unique way of trading, and their specific responses to the rapid market changes observed on May 6 are quite nuanced.
You can practically see their *wide eyes*
12:47 We count 73 footnotes. This # just beats how many Ray Dalio has in his “Bridgewater Principles”
12:51 We see NO policy recommendations yet BTW. We do not expect there to be any, as mentioned earlier this morning.
12:52 LOL @ a headline of a section called “Potential Impact of Additional Factors.”
12:59 The report vindicates the NYSE. They say the NYSE’s LRPs did not create or cause the “broad-based” liquidity crisis during flash crash. The NYSE is the first exchange mentioned by name (we’re not reading in order). *LRPs are “pauses” that are triggered by price volatility. LRP stands for liquidity replenishment points. Normal daily numbers (of LRPs lasting more than a second) are 20-30. During the Flash Crash (from 2:30-3 pm) they were at 1000.
From the report:
During a LRP, automatic executions will cease for a time period ranging from a fraction of a second to a minute or two to allow the Designated Market Maker (“DMM”) to solicit and/or contribute additional liquidity.
So you can see why the NYSE might have been somewhat blamed for decreased liquidity during the flash crash, as they were. The report determines that their speed bumps had no direct effect on the flash crash, they were just a result of it.
1:11 Look what we found on pg 67:
It says most stocks behaved normally that day:
The vast majority of the almost 2 billion shares traded on May 6 between 2:40 p.m. and 3:00 p.m. were at prices within 10% of their 2:40 p.m.
Just a few stocks experience the extreme price movements that Accenture and the DOW did.
For most of the trades executed at a loss on May 6, their declines were consistent with the general declines in the broad market indices.
And everything jumped back to normal perfectly (this is why Jim Simons said the Flash Crash was beautiful):
We note that many of the securities that suffered rapid price moves found their prices reverting to their former levels nearly as quickly. This suggests that immediately-available liquidity was not able to fully absorb the considerable demand to sell (and in some cases buy) shares, and that prices recovered as soon as this pressure was reduced and the imbalance alleviated.
So far that’s our favourite part. Succinct and in line with what we’ve heard traders say about the events of that day.
1:23 This is 104 pages btw. just FYI
1:29 Watching CFTC’s Chilton on CNBC right now. He has a silver mullet. Not kidding. He just said “The Flash Crash COULD happen again today, but it’s less likely to.” — our question is WHY is it less likely to happen again? What changed? (We just got an answer from a trader: Circuit Breakers.)
Back to reading.
1:33 On breaking trades (which the NYSE did not do), the report says:
Though the type of volatility experienced that day is very unusual, even more extraordinary was the fact that over 20,000 trades representing 5.5 million shares were executed at prices more than 60% away from their 2:40 p.m. value. These trades were subsequently broken by the exchanges and FINRA under their clearly erroneous rules because they were executed at clearly unrealistic prices under severe market conditions.
The SEC updated the “clearly erroneous” trade-breaking rules on Sept 10.
1:37 WOAH! NYSE Arca is called the hero of the day! In lesser words. The Last Provider of Liquidity.
The fact that a single market maker on NYSE Arca represented so many broken trades suggests that this market maker was one of the last providers of liquidity for those securities in that market. Other market makers had either stopped quoting or were quoting at even lower prices, demonstrating the extent to which liquidity had virtually evaporated.
1:49 We just posted 25 of the best charts in the report. Click here to see them >>
2:17 We found a place where the SEC defines high frequency trading! Check out the definition here >>
2:36 Ok we’re up to the SEC’s analysis of the most immediate causes of the Flash Crash. Looks like they separate the potential “problem makers” into 6 categories: Intermediaries, HFTs, Fundamental Buyers, Fundamental Sellers, Noise Traders, and Opportunistic Traders.
2:40 This is weird, on pg 16 inside the analysis of the immediate causes we mention above:
For classification purposes, both Intermediaries and HFTs were treated as “market makers.”
Why? Market-makers are defined as firms which are required (by registration) to make a market for a trade, an in the case of the flash crash, would have been required to continue buying when no one else was. It’s explained even more confusingly in a footnote:
For the purpose of this report the term “market maker,” when used only in the context of the E-Mini, reflects a style of trading, not a formal registration requirement.
Many think one of the problems with HFTs is that they aren’t required to register as market makers, so they can trade whenever they want, and when stuff like the flash crash happens, they can just stop trading.
It’s kind of a hot button issue, so we’re confused why the SEC would just act as though HFT are already market-makers, when they aren’t. It’s like saying, “For the purposes of this report, every dollar Wall Streeters earned in their TARP bonuses were returned to the public.”
It makes us think that the SEC isn’t going to do anything in the mode of requiring HFT firms to register as market-makers anytime soon. Because they’re just assuming they are already market-makers, the SEC aren’t addressing the issue of what the difference is on the market between when they are and when they aren’t market making.
Conclusion: The most interesting thing we’ve found in there so far is that the SEC calls HFT firms market-makers just for the hell of it.
We’ll continue reading the report this weekend, so check back on Monday, but for now, our conclusion is that they blamed Waddell and Reed’s e-mini futures orders, don’t agree with cancelling orders if another flash crash occurs and completely vindicated the NYSE.
For more on the conclusion, click here.