The term Flash Crash didn't exist until May 6, 2010 when the spontaneous, inexplicable and dramatic 1,000-point plunge and subsequent rebound of the stock market left an indelible scar on investor psyche. There have been a few small but well-contained instances since then, but for the most part, the Flash Crash was a one day event.
Speaking for myself, and an unscientific survey of friends and contacts in the business, no one believes that it won't happen again. In fact, at least one expert thinks it not only could happen again, he thinks it will happen again and will be so large and interconnected with other asset classes and exchanges, that he's coined the term "Splash Crash" to reflect the predicted spillover effect.
"Our concern is, with extreme correlation between different asset classes - equities, futures, commodities, energy and foreign exchange - a flash crash in one asset class could spill over... this could lead to an even bigger crash" says John Bates, the Chief Technology Officer of Progress Software and consultant to the Commodity Futures Trading Commission.
To be fair, the original Flash Crash spawned a six-month probe led by the Securities and Exchange Commission that resulted in a series of new trading limits or collars that halt trading when irregularities occur. So far, it has largely worked for the stock market, but experts like Bates think a lot more needs to be done in a lot more places.
"The fear is, there are elements we haven't discovered yet," which is why Bates is calling for "better real-time market surveillance." Specifically, he would like to see "pre-trade risk management put in place across all asset classes." This would enable regulators to detect patterns of abuse as it is happening, be able to stop anomalous trades from going out into the market, and lock-down a trading program (or algorithm) that is infected or out of control. And this is where it starts to feel like Big Brother to me.
Few people would argue against the need for regulators and exchanges to maintain an orderly marketplace or what Bates calls "better back-testing, risk firewalls and market surveillance." However, staffing and paying for such an operation raises many questions, as does the thought of getting a government stamp of approval BEFORE you can make a trade.
The risk is clear and present. The solutions, unfortunately are not.
Will there be another another Flash or Splash Crash? Let us know what you think below, or email us: Breakoutcrew@yahoo.com