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Algorithmic trading caused the flash crash: An explainer

David Pogue
Tech Critic

On Monday, the stock market did something weird. Sure, it was sinking through the day — but then, at about 3 p.m. ET, it plummeted. Nobody could figure out why. There was no big headline, no sudden announcement.

“The drop in the morning was caused by humans, but the free-fall in the afternoon was caused by the machines,” wealth manager Walter “Bucky” Hellwig told Bloomberg.

Hup — there it is. Algorithmic trading caused the flash crash.

My “Midday Movers” producer asked me to offer an explainer for “algo trading,” as it’s nicknamed —but really, it’s not hard to grasp. Algo is when you program software to buy or sell stocks automatically, based on timing, price, quantity, or some mathematical model.

Algorithmic trading has a number of benefits: It rules out human emotion; it places trades instantly and precisely, locking in at the values you want; and lets institutional investors (like mutual funds and insurance companies) buy or sell huge quantities of stock in many smaller blocks, so as not to affect the stock price in the process.

Algo trading also, however, tends to magnify upward or downward trends, as we saw yesterday. Fortunately, the market largely recovered after the algo-driven selloff — maybe because humans came back to their desks.

David Pogue, tech columnist for Yahoo Finance, welcomes non-toxic comments in the Comments below. On the Web, he’s davidpogue.com. On Twitter, he’s @pogue. On email, he’s poguester@yahoo.com. You can sign up to get his stuff by email, here.