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Guest Post: Are You Really Protected From Another Flash Crash?

Tyler Durden's picture




 

Submitted by Themis Trading

Pop Quiz:  Let’ s suppose, hypothetically, you are  trading a
non-Russell 1000 stock.  All of the sudden, out of nowhere, the network
at a major exchange is hacked by some foreign intruders.  Data becomes
corrupted and the high freak “liquidity providers” head for the exits as
fast as they can.  Stop limits are being triggered everywhere and the
phantom bids that represent today’s equity market have all but
vanished.  Your sell order gets executed 29% away from the last trade. 
Exchanges are able to quickly locate the source of the network intrusion
and shut down the hackers (we know, not likely, but just play along). 
The stock you were trading quickly recovers after it brief loss and is
now back to trading at its pre-hack level.  In addition to your trade
that got executed 29% lower, there were over 200 other “bad trades” that
were executed far from the reference price. Question for you:  Does the exchange break your trade since it was “clearly erroneous”?

If you answered “No”, then you are correct.   How can that be, you
say.  Didn’t the SEC put in place all sorts of rules since the May 6th
“Flash Crash” that would protect your order from this type of
situation?  Well, in September of 2010, the SEC approved a little known
FINRA rule request (Rule 11892) which created a new category for
breaking of “clearly erroneous trades”.  The new rule (which is
currently in a pilot program) says:

“With respect to multi-stock events, the amended rule creates a new category-multi-stock event involving 20 or more securities-to address clearly erroneous reviewsregarding executions in 20 or more securities that occur within a period of five minutes or less. Once a multi-stock event is triggered, FINRA will coordinate with the exchanges and nullify as clearly erroneous all transactions at prices equal to or greater than 30 percent away from the reference price in each affected security”

 Basically, this means, should there be another “flash crash” type
event, where there are over 20 securities with erroneous trades, only erroneous trades 30% or more will be broken  For the full list of what will and what will not be broken in case of errors, click here: FINRA notice

So, why are we talking about this today?  Because on Monday, 4/25/11,
between 9:28am and 10:02am, 84 stocks traded at prices that were far
away from their previous price.  What, you didn’t hear about this? 
That’s probably because the alleged source of the problem, NASDAQ, would
probably rather not have this story in the press considering they are
still playing the Dating Game with the NYSE.  NASDAQ released this post
mortem yesterday:

 “On April 25, 2011, NASDAQ experienced an issue
with the Market Maker Automated Quotation System whereby a subset of
securities had invalid market data. This caused the automated quotes in
those securities to be posted at aberrant prices starting at 09:28:00.
The application that controls these functions was updated and at
10:02:42 the system was normalized. NASDAQ has determined the root cause
of the issue and has taken steps to avoid the likelihood of future
occurrences.”

First of all, what exactly does “experienced an issue” mean?  Was this a computer malfunction or something more nefarious? 

Secondly, what is the Market Maker Automated Quotation System?  Well,
this is Nasdaq’s recently approved system which automatically  posts
quotes for “market makers”.  Click here for FAQS
 We remember way back when Nasdaq had real market makers that posted
their own quotes which were at the NBBO because these market makers
needed to trade stocks.  Nowadays, a “market maker” is likely just a
machine sitting in a sterile, cold server room that gives instructions
to make sure their quotes are far enough from the NBBO so they will not be executed
but close enough so they enjoy the privileges of being a market maker. 
Rather than discouraging this type of behavior, Nasdaq seems to be
encouraging it with their Automated Quotation System.

This little innovation by NASDAQ which was created to assist their
automated, high volume clients is just more of what we have seen from
the for-profit exchange model.  Make no mistake, the exchanges are in
the business of making money first and investor protection seems to be
only an afterthought nowadays.  This non-stop quest for profits by the
exchanges has been revealing flaws in their models.  This time it was
only 84 stocks.  What happens if next time it is 1084 stocks or 4084
stocks?

 

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Wed, 04/27/2011 - 10:06 | 1211317 FoieGras
FoieGras's picture

The Flash Crash is so 2010. Move on already.

Wed, 04/27/2011 - 10:05 | 1211319 CheapPanderingCrony
CheapPanderingCrony's picture

x

Wed, 04/27/2011 - 10:16 | 1211368 Hard1
Hard1's picture

Actually something very similar happened to an aquaintance.  His stop loss got executed at a level waaaay below where the stock was trading, there were some trades at those prices in seconds and the stock went back to it's former levels.  Actually this was an ADR and the foreign stock wasn't moving much.  My take is that the algos "sniffed" low liquidtity and can execute stop losses at a profit by micro flash crashing illiquid stuff.

Wed, 04/27/2011 - 10:05 | 1211323 buzzsaw99
buzzsaw99's picture

Yeah, and JPM sets the "reference price" based upon their positions.

Wed, 04/27/2011 - 10:06 | 1211328 trav7777
trav7777's picture

I picked up stuff on stink bid on FlashCrash day...was a great buying opp

Wed, 04/27/2011 - 10:40 | 1211496 Monday1929
Monday1929's picture

You like good prices? I guess you are cheap.

Wed, 04/27/2011 - 10:08 | 1211336 BeerGoggles
BeerGoggles's picture

What's all this about 30%? Aren't the breakers supposed to kick in at 10% until the next trading day?

Wed, 04/27/2011 - 10:39 | 1211382 Cognitive Dissonance
Cognitive Dissonance's picture

30% is the new 10%. Didn't you get the momo memo?

Wed, 04/27/2011 - 10:46 | 1211509 BeerGoggles
BeerGoggles's picture

WTF is all this 30% BS then?!

Wed, 04/27/2011 - 11:04 | 1211646 Cognitive Dissonance
Cognitive Dissonance's picture

Clearly you did not read the momo memo. Probably because you weren't sent it. Just like there was little publicly said about 80+ stocks flash crashing. I wonder why the press wouldn't make that a front page item?

Well, in September of 2010, the SEC approved a little known FINRA rule request (Rule 11892) which created a new category for breaking of “clearly erroneous trades”. 

Wed, 04/27/2011 - 11:13 | 1211710 BeerGoggles
BeerGoggles's picture

Yep, bt the circuit breakers still stop it at 10% so again, WTF is this 30% bullshit. It can't get to 30% in 1 day.

Wed, 04/27/2011 - 12:03 | 1211919 Cognitive Dissonance
Cognitive Dissonance's picture

It most certainly can when the computers are in charge and it quickly drops past the 10% triggers. How many times have you gotten a worse price than your trigger price because the market moved so quickly? How can the breakers trigger if the tape is 10 or 15 minutes delayed? It's only after the fact that the exchange can say this or that happened. So they pull an arbitrary number out of their ass (30%) and move on. We all know the next flash crash will be much worse than last May 6th.

Wed, 04/27/2011 - 10:08 | 1211337 6 String
6 String's picture

This article is a waste of fucking time. Who would be dumb enough to sell during a flash crash with the Ponzi at the helm? They would never allow a flash crash to settle and consolidate. Don't hold your breath, either. If one did happen, it will look like May 6th. Big whoppie fucking do. Unless you are stupid enough to have stops in place within the 30% band. If you're that stupid, you get what you deserve.

Moody's to the moon. Now, that is the story today fellas.

Wed, 04/27/2011 - 10:19 | 1211402 KevinH
KevinH's picture

You could set a stop at say, 2% below the current price, bids drop out, and you get filled at 10% below. Ofc, you could set stop limits but that has certain other risks.

Wed, 04/27/2011 - 10:12 | 1211344 RobotTrader
RobotTrader's picture

Moody's is flash crashing up.

Zandi's reward for re-affirming the AAA-rating on U.S. Treasuries after S & P dropped that bomb last week.

Wed, 04/27/2011 - 10:12 | 1211364 Internet Tough Guy
Internet Tough Guy's picture

No TZOO chart today, morontrader? IBD CANSLIM riverboat momotraders must be scratching their heads at the ultimate inflation hedge that dropped 12% yesterday. And I see you are now openly mocked on the other board. LOL. You must be puking up blood!

Wed, 04/27/2011 - 10:28 | 1211437 lieutenantjohnchard
lieutenantjohnchard's picture

remember in january how he pulled the zlc chart out and mocked silver holders for being stupid. said retail was back.

zlc then $5.88. today $3.70. silver's doubled.

and not surprisingly no zlc chart either. but that's as expected from the world's worst trader.

Wed, 04/27/2011 - 10:11 | 1211357 LawsofPhysics
LawsofPhysics's picture

TPTB always changes the rules to protect their interests - keeping them in control, period.

 

A lot of blood will need to be spilt before anything changes.  When you are 30+ years into fraud and the ponzi, there is no other alternative.

Wed, 04/27/2011 - 10:17 | 1211394 Rogerwilco
Rogerwilco's picture

Be careful what you wish for, "like Saturn, the revolution devours its own children".

Wed, 04/27/2011 - 10:14 | 1211361 Hansel
Hansel's picture

Have a cartoon,

Benron Gets A Headache

At the Feral Reserve’s first ever press conference, questioning gives Benron a headache.

Wed, 04/27/2011 - 10:15 | 1211375 buzzsaw99
buzzsaw99's picture

If he has a headache it is because he has Jamie Dimon's fist up his ass.

Wed, 04/27/2011 - 10:14 | 1211369 Thorny Xi
Thorny Xi's picture

People still own stocks?

Wed, 04/27/2011 - 10:15 | 1211373 Rogerwilco
Rogerwilco's picture

"high freak"

LOL - he meant "high freq", but the term in the article may be true in the larger context.

Wed, 04/27/2011 - 10:18 | 1211397 fuu
fuu's picture

What happened to those awesome NANEX charts? The Q1 2011 flash crash issue was awesome. i would love to turn more of them into youtube videos.

Wed, 04/27/2011 - 10:28 | 1211428 innsbrooklad
innsbrooklad's picture

The market is a mile long and an inch thick..The high frequency MITs guys and the hedge funds are all long and pushing trhe dopes at funds into a market that really has no bid..Flash Crashes occur when you have no bids under the market, like now...You see volume????Take away the computers and there is none...

Wed, 04/27/2011 - 11:14 | 1211713 BeerGoggles
BeerGoggles's picture

The market is a mile long and an inch thick..

Like my cock

Wed, 04/27/2011 - 10:31 | 1211449 RobotTrader
RobotTrader's picture

Virtually every oil and gold stock ETF is getting flash crashed today.

Wed, 04/27/2011 - 10:42 | 1211493 lieutenantjohnchard
lieutenantjohnchard's picture

virtually every one of robottraders favorite stocks getting flash crashed today: lulu, tzoo, zlc.

Wed, 04/27/2011 - 10:46 | 1211512 6 String
6 String's picture

Silver always flash crashes when ZH gets all wet over price rise and posts at least three times in one day. I wonder if ZH is long silver? LOL.

Wed, 04/27/2011 - 10:42 | 1211492 cowdiddly
cowdiddly's picture

Wait till Iran sends Stuxnet II back to Wall Street.

Wed, 04/27/2011 - 10:47 | 1211511 JustPrintMoreDuh
JustPrintMoreDuh's picture

that is some seriously funny shit hansel

Wed, 04/27/2011 - 10:47 | 1211518 InconvenientCou...
InconvenientCounterParty's picture

house rules bichez...

Wed, 04/27/2011 - 10:49 | 1211529 his_name_is
his_name_is's picture

First!

Wed, 04/27/2011 - 10:58 | 1211619 dwdollar
dwdollar's picture

LOL...  You're the man Kudlow!  You never take your eyes off the ball.

Don't worry everyone.  The near prophetic visions of CNBC hosts will get you out before everyone else.

Wed, 04/27/2011 - 11:03 | 1211649 WTF_247
WTF_247's picture

You cant fight the rules made to protect the idiocy of hft's.  However, if you look into the rule, you can figure out how it is VERY easy to profit from it.

Create your own algos, they do not even have to be that complicated.  You simply bid for several hundred names 29% from last bid price, and put in short sale orders on every name 29% above last ask price.  These are in there 100% of the time, constantly changing with the market.  Simply wait for the issue to happen, and profit from it.

Granted, there might be a few times where you get nailed on a name that has specific bad or good news on it and be on the wrong side with a loss.  However, if you think about it, 1 flash crash day you would profit immensely, like today.  If you grab 20-30% on only 3 names, that would make up for even a 100% loss on a name you buy which crashes and goes to 0 (unlikely) because of news like fraud etc.  It would also make up for any names where you short it and its running up on a takeover etc.

There is no rule barring anyone from putting in multiple limit orders, so why not profit from the idiots?

Wed, 04/27/2011 - 11:50 | 1211867 Crispy
Crispy's picture

A few lessons I have learned in my 16 years in the markets as a pro.

Resting stops are for chumps - use mental stops. Conditions and ideas can change faster than your can adjust an order. 

And the best thing to do when you dont know what to do is nothing, right away. Walk away...think if your thesis has changed before making a rash decision. Let price action stabilize then react.

First two are free the third is in your mouth...

Wed, 04/27/2011 - 11:48 | 1211874 heaven
heaven's picture

Use stop limit orders. No blood no foul.

Wed, 04/27/2011 - 12:29 | 1212021 ThirdCoastSurfer
ThirdCoastSurfer's picture

Funny how quickly markets will abandon the validity of greeks, how viruses are Trojan horses and how God is the alpha and the omega but gives unto Caesar..... 

 

Wed, 04/27/2011 - 16:26 | 1213413 AldoHux_IV
AldoHux_IV's picture

Market structure is flawed-- not surprised considering every other macro structure is as well-- let's not upset the apple cart shall we.

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