Flash Crash Mystery Solved

Tyler Durden's picture

Via Nanex

Flash Crash Mystery Solved

Below are portions of a comment letter submitted by R.T. Leuchtkafer to the SEC on April 16, 2010, just 3 weeks before the flash crash. The second paragraph in the excerpt below, unknowingly describes exactly how the flash crash was started. The letter goes on to alert the SEC on the dangers of High Frequency Trading (HFT), phantom liquidity and other concerns.

Our exhaustive analysis of the May 6, 2010 Flash Crash included:

  1. processing trillions of exchange quote, trade and order book records for stocks, options, and futures on May 6th and other trading days back to 2005 and days since.
  2. matching up the actual 6,438 trades (75,000 contracts) executed by Barclays for Waddell & Reed to the 147,577 trades executed in the CME June 2010 eMini during that time.
  3. drawing from extensive interviews with authors of academic and regulatory papers on the Flash Crash.
  4. conversations with dozens of traders, programmers, investigative jouralists, government officials in the U.S. and abroad, anonymous callers, and "people familiar with the matter" since June 2010.
  5. finding and studying similar crashes in the eMini and crude oil and thousands of other anomalies.

From this, we were able to zero in on the ignition point, or starting time of the crash: 14:42:44. That is the moment when one or more large HFT "market makers" hit their limit of long positions in the eMini Futures (ES.M10), and reversed out - "readjusted their position". Immediately. That aggressive act sucked out a significant amount of liquidity and caused thousands of trading instruments (stocks, options, indexes, futures) to reprice, which severely overloaded all trading systems processing market data (peak message traffic set a record at that time, which was not exceeded for the balance of the day). Overloaded systems caused bad, delayed, and unexpected pricing to appear, which caused other algos and traders to stop trading, removing any remaining liquidity. We know the Waddell & Reed algo practically ceased trading shortly before the 600 point slide in the Dow Jones Industrial Average; selling a mere 1000 contracts in small lots (averaging 6 contract per trade), all on the offer side. No Virginia, the Barclay's algo used by Waddell & Reed did not sell indiscriminately without regard to time or price: it didn't take liquidity either. That was the work of HFT. In short:

High Frequency Trading caused the Flash Crash. Of this, we are sure.

If the above isn't enough damning evidence, in the paper Moore’s Law vs. Murphy’s Law dated March 19, 2013 co-authored by Andrei Kirilenko, the former CFTC chief economist and principal author of the final SEC flash crash report (page 11), finally agrees:

...After buying the E-mini for about 10 minutes, high frequency traders reached their critical inventory levels and began to quickly and aggressively unwind their long inventory at a key moment when liquidity was sparse, adding to the downward pressure. High frequency traders rapidly passed contracts back and forth, contributing to the “hot potato” effect that drove up trading volume, exacerbating the situation. Meanwhile, cross-market arbitrage trading algorithms rapidly propagated price declines in the E-mini futures market to the markets for stock index exchange-traded funds like the Standard & Poor’s Depository Receipts S&P 500, individual stocks, and listed stock options. According to the interviews conducted by the SEC staff, cross-market arbitrage firms “purchased the E-Mini and contemporaneously sold Standard & Poor’s Depository Receipts S&P 500, baskets of individual securities, or other equity index products.” As a result, a liquidity event in the futures market triggered by an automated selling program cascaded into a systemic event for the entire U.S financial market system. As the periods during which short-term liquidity providers are willing to hold risky inventory shrink to minutes if not seconds, Flash-Crash-type events—extreme short-term volatility combined with a rapid spike in trading volume—can easily be generated by algorithmic trading strategies seeking to quickly exploit temporarily favorable market conditions.

That key moment in time was 14:42:44.

Finally, we can close the books on investigating the cause of the flash crash.

Note to journalists.

The HFT lobby will vehemently deny any blame for causing the flash crash and will use a number of straw man arguments, eventually enlisting the SEC final flash crash report which named Waddell & Reed as the cause (W&R). Here are some key points to remember:

  1. Always ask for data used to back up any claim. You will find a lot of people are long on talk, woefully short on data. Data is difficult to obtain and takes a lot of expertise to work with: use that to separate the wheat from the chaff.
  2. The SEC publicly stated numerous times that it took them 5 months just to receive and organize the vast amount of market data. 5 months from May 6th is October 6th, yet they published their report on October 1st. When did they have any time for analysis?
  3. W&R used Barclays to execute the algo (a fact not mentioned in any SEC report).
  4. The regulators (CFTC) first interviewed the Barclay team that executed the W&R trades on October 14, 2010 - yet published the final flash crash report 2 weeks earlier, on October 1, 2010. Why this has never been mentioned in the media is a mystery.
  5. Barclay's algo only sold at the offer, never crossing the bid-ask spread during the crash: it was entirely passive, and did not move the order price lower once entered. This type of passive algorithm cannot cause a market crash on its own.
  6. Barclay's algo only sold about 1000 contracts during the entire 600 point slide in the DJIA. It did not accelerate selling as the market began to drop. To claim otherwise is simply untrue.
  7. Barclay's algo sold heavily after the eMini circuit breaker ended and the market had bottom: a period of maximum chaos, severely delayed feeds and minimum liquidity. Yet market prices climbed.
  8. The SEC final flash crash report incorrectly uses the word liquidity 249 times in 89 pages. It is worthwhile reading about this monumental logic error.
  9. Barclay's and W&R gave the actual trade executions to Nanex for analysis and we were able to match up those trades to the CME time and sales so we have a true and accurate picture of how the algo executed. We know exactly which trades came from W&R and an exact picture of how the market looked when each one executed.

This is a very complex subject and lobbyists will use that to bamboozle you. Feel free to ask questions at the email below. Also, be sure to watch this award winning documentary (Money & Speed) which captures Eric Hunsader of Nanex on film formulating what turned out to be, the actual cause of the flash crash.

Comment viewing options

Select your preferred way to display the comments and click "Save settings" to activate your changes.
Pairadimes's picture

Who the hell else is in the market?

notbot's picture

A+ stuff, Nanex.  Great work. 

aka Gil's picture

It doesn't matter how nicely you present a gift to the SEC, they don't give a fuck because they don't work for us. Just ask Harry Markopolos if you don't believe me.

Groundhog Day's picture

Don't worry no one will go to jail or be indicted for the billions lost.  Just another day in the neighborhood at the SEC.  They are now just  a wholly owned susidiary of JPM and GS

Zero_Sum's picture

Of course, 'Leuchtkafer' is a pseudonym. Still curious who actually wrote that letter.

AlaricBalth's picture

Leuchtkafer is German for firefly. The personification of a small light in the darkness, maybe.

This link takes you to his (or her) Bibliography of HFT Studies.

"The bibliography attached to this note includes nearly a century’s worth of evidence-based research discussing the effects of market maker scalper business models on markets around the world. Several papers describe how scalpers are not just simple passive market makers, as sometimes imagined, but trade aggressively on information they glean from their many privileges.

Several papers also describe how unregulated or unconstrained market maker firms manage inventory, and how, in volatile markets, these firms can exacerbate price volatility by trading as quickly and aggressively as they can, just as happened in the Flash Crash. The bibliography also includes evidence- based research papers that explore the benefits of market maker regulations and obligations in stock markets that have tried them, including, somewhat ironically, the U.S. itself before deregulation.

Finally, several papers discuss the effects of high frequency trading of all types on today’s markets."

fuu's picture

Leuchtkafer = Hacker Flute and Leather Fuck

Bear's picture

Now can I sue for the $11,000 that I lost that day? Or does the explanation conveniently come after the statue of limitations expires?

sitenine's picture

Fuck NO, you can't sue! In fact, you should slap yourself silly for having money in this Fed sponsored and SEC sanctioned casino in the first place.

Pure Evil's picture

Sure, you can sue, but expect to lose another $11k (or more) to the lawyer.

Schmuck Raker's picture

SEC response: Move along...nothing to see here...return to your dwellings.....we have assumed control

thatthingcanfly's picture

Kim Kardashian was spotted wearing a baby-bump-hugging dress today.

cifo's picture

She still goes to the gym?????

ultimate warrior's picture

It's just what free markets do....move along


Umh's picture

I think that this sentence can be applied to a number of different government regulatory areas.

"Someone once suggested the real scandal is often not what is illegal but instead what is legal."

disabledvet's picture

First comes the bamboozlers...then it's full on balderdash. After that it's "dummy up and talk to legal."

putaipan's picture

is this a good time to mention the monsanto protection bill?

notquantumdum's picture

I locked in 5% profits (plus) in 24 hours, buying the lows in various securities during the flash crash after the bottom, and then selling them the next day.

But, I am strongly opposed to BS regulation and enforcement like this seems to indicate!

I would much rather have not made the profits, and not had the flash crash happen.

nanex's picture

Good one!


Now, photo copies of brokerage statements or it didn't happen.



notquantumdum's picture

sorry, don't care if you believe me when I tell the truth.

I would rather stay as anon as poss.

BackOffice Slut's picture

you can easily stay anon. Black out name, address, and all that important stuff. I mean, if i made 11k that day i'd show that shit off!

Pure Evil's picture

You don't have to show the brokerage statements. Just explain the process of how you went about buying the lows in various securities after the flash crash in excrutiating detail.

If you like, you can use the charts from this ZH post about the flash crash to explain to us how you were able to buy at the bottom and sell the next day, especially since the bottom lasted all of about 2.5 minutes.

Now, don't be shy, and try to remember. If you can't dazzle us with your brillance, then dazzle us with your bullshit.

notquantumdum's picture

You seem to exaggerate in my recollection.  I remember having longer than 2.5 minutes to decide.

Look at where the older lows and highs occurred, farther back, it's amazing how useful that is.  Look for volume traded, that is very important.

I seem to remember hours being involved, but maybe my memory is not quite remembering well.

Pure Evil's picture

Yeah, your memory sucks like a dementia patient at a skilled nursing facility.

So, are you trying to imply that a FLASH CRASH lasts hours?

Don't try to snake us with mumbo jumbo about older highs and lows and volume traded. From Nanex's own charts the FLASH CRASH lasted all of approximately six minutes.

If you go look at a few of the charts I provided through the link, YOU, and everyone else can see the truth and the proof provided by Nanex and ZH.

Still waiting for the detailed post explaining how you executed trades from your mother's basement when computers co-located to the exchanges running HFT algo's weren't allowing any outside trades to be executed since they were widening the spreads making it impossible for people without computers co-located to the exchanges running HFT algos to get accurate bid/ask spreads. Go back and read the last paragraph from the excerpt. What that paragraph is trying to say is that the co-located computers running HFT algo's were using up all the exchanges run time so that no other computers except those co-located were able to obtain time slices with the exchange computers. Effectively blocking all other executions.

Please explain your exact process for the times between approximately 14:53:30 and 14:48:30.

If a birth certificate can be forged so can brokerage statements.

notquantumdum's picture

'And, I respect your presumed integrity for asking.

slightlyskeptical's picture

Same here. Have to admit that all my buys were GTC orders put in weeks earlier, that I had completely forgotten about. Turned out to be a nice day.

fonzannoon's picture

I was sitting right there when that crash happened. I went after it and tried to buy a few things. I put in market orders. Stupid move apparently. They got filled, but only on the way back up at way higher prices than I was staring at when I hit submit. Ended up being one giant non event.

nanex's picture

I have heard this same story from many people. Fidelity wasn't able to give fills until hours after the market close. There are lots of people out there fuming. Still.



fonzannoon's picture

You don't know how much so many of us appreciate what you do nanex. Thank you.

notquantumdum's picture

You, are correct, I believe.

I have multiple brokers with multiple accounts, and I seem to remember them going on and off-line at different times.

It was nice having more than one broker, for sleeping at night.  But, it didn't seem to actually end up helping me much given than I never really ended up wanting to conduct a trade during the relatively somewhat short outages which I experienced -- and I wasn't intentionally short-term trading at that time, thankfully.  I think I might have been somewhat lucky.

Outages are hated, but they do happen, from time to time.

Tapeworm's picture

If you are the real NANEX, you have my eternal respect for what you have done to lay it out for the rubes like me. No kidding, what you have done should have been the talk of every Sunday morning MSM TV gab fest.

 What sickens me the most is that NANEX did the work gratis for the gombit regulator filth and they do all to bury the information. That is why I see no hope.

 Nevertheless, NANEX is tops on my Hero list. I cannot think of anyone else that has done more.

notquantumdum's picture

I HATE market orders with a capital H!

But, I will enter them sometimes, every once in a while, if and only if desperate enough, in a totally adequately liquid-security, when I can't seem to obtain an execution any other way, time and time again.

What else are they good for?

(PS, Doesn't that almost have to mean that I am daytrading, if that is my criteria?)

notquantumdum's picture

'should say, ". . . my criteria for needing to use a market order", so who else needs a market order.

dark pools of soros's picture

market orders are fine when you are waiting to dump the yearly vested golden handcuffs your corp zombie job grants you.. like gruel you chug it as fast as you can


notquantumdum's picture

They're apparently short-termers, also, huh?

Maybe focusing more on the longer term would be useful?

dark pools of soros's picture

and a day late to the next crash = ?

lock in gains and spread it around elsewhere


notquantumdum's picture

Spreading risks out well is apparently almost always a good thing to do.  That is exactly what I have been trying to suggest in recent posts, if not do myself, given the obvious challenges in trying to do this, even though one will not necessarily have a whole lot of certainty as to how things will play out . . . usually.

If only our "leaders" could do so well.  They seem to always maximize the opposite.

There is nothing wrong with sticking to one's goals, even if challenging, I think.

'Don't let the bums get you down, when you know you're right!

StandardDeviant's picture

lock in gains and spread it around elsewhere

...including (compliance rules permitting) using part of those gains to buy some cheap OTM puts on the thing!

If you're the CFO, say, there's an obvious moral hazard.  But if you're just another Joe Employee, whose salary (and benefits, pension, etc.) are entirely dependent on the company, your investment portfolio should act as a hedge, not push you even further long in the same direction.  Just ask any ex-Enron employee.

notquantumdum's picture

Instead of "BS" regulation and enforcement, maybe, too much bad, and not enough good, regulation and effective enforcement, might be a better way to phrase things. . . .

notquantumdum's picture

'Received a number of negative ratings, but i'm certain i was adding liquidity during these events (based on the above def) because I was only entering limit order which were outside of the current market prices, during the flash crash.

'Complain if you will, but what else is one supposed to do?

YC2's picture

Not being a robot, my impression that day was that throwing a market order into that chaos was asking for trouble. Slip city.



Every crisis provides opportunities.

Be glad you profited.

These crisis opportunities will become more frequent

rather than become fewer as the system collapses.


Sathington Willougby's picture

Kirilenko runs a communal agenda with his "anti-profiteering" pre-disposition towards "economics".  What pseudoscience drivel is this brought by flower children?


Please, refrain from entering voluntary contracts if you don't have the fortitude to to take responsibility for your capital and risk exposure.  Perhaps you should invest in government bonds.


Two types demand zero risk returns.  Neither reach the level of human being.  One would be human stealing and the other human begging. 

knukles's picture

Oh come on, it was more fun blaming Waddell & Reed.

piliage's picture

Exactly. It was all the fault of those BBQ eatin' hicks in KC, who actually according to the video bought an order at the very bottom and sold at the very top, not the zillion high liquidity market moving millisecond ordes by 'unnamed large banks protected by the sec due to disclosure rules'. Spit

IridiumRebel's picture

I don't know what any of this shit means. I just buy the fucking dip.