Thursday, May 6, 2010

Why Thursday's Market Crash Was Caused by Computer Failure or Errant Trades

The 'Helicopter Economics Investing Guide' is meant to help educate people on how to make profitable investing choices in the current economic environment. We have coined this term to describe the current monetary and fiscal policies of the U.S. government, which involve unprecedented money printing. This is the official blog of the New York Investing meetup.

The trading pattern on the U.S. markets on Thursday, May 6th can be explained by only one of two things - a huge erant trade or a computer system failure.  Even after the market close, the NYSE was claiming that there were no technical problems with its trading system. Citi specifically issued a statement that it had nothing to do with implementing an errant trade. Nasdaq however said that it was investigating possible erroneous transactions executed between 2:40 and 3:00PM.

It wasn't so much the drop that was unprecedented. The waterfall decline that took place for approximately eight minutes somewhat after 2:30PM is common in crashes. Even during crashes however, numerous intra-period gaps on the one-minute chart aren't common. There were four such gaps yesterday in S&P 500 trading. Large market indices almost always trade continuously and the probability of this type of trading pattern is extremely small. Even less probable was the instantaneous recovery of the indices. The S&P 500 also has four gaps on the upside in only eight minutes, when it rose approximately 50 points.  During that same time the Dow Jones Industrial Average was rising around 500 points. None of this represents a normal trading pattern.

The major indices were damaged enough as is on the day.  The Dow was down 348 point of 3.2%. The S&P 500 dropped 38 points or 3.2%. Nasdaq gave up 83 points or 3.4% and the small cap Russell 2000 lost 28 points or 4.0%. Of all the major sectors, financial stocks were hit hardest closing 4.1% lower. The confusion caused the VIX, the volatility index, to spike above 40. It was in the mid-20s only two days ago. It closed at 33.19, up 41% on the day. This type of movement in the VIX is extreme and is likely to be reversed in short order. Gold rallied in the confusion.

Having looked at the charts as the sudden trading plunge and the subsequent recovery that took place during and after the market close, I noted the charts changed over time. Some of the gaps on the charts disappeared and a straight-line trading pattern the existed for a while before and just after 3:00 disappeared on later charts. The straight-line trading pattern only exists if trading has been halted or if there has been a break in the information feed from the exchanges so no data is forthcoming. Either way, traders and investors are entitled to an explanation of what really went took place. Otherwise, they might think there is either a cover-up of a serious technical glitch or collusion by the big players in manipulating the market.

Disclosure: Sold VXX.

Daryl Montgomery
Organizer, New York Investing meetup

This posting is editorial opinion. Like all other postings for this blog, there is no intention to endorse the purchase or sale of any security.

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