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Old 10-01-2010, 04:04 PM
2pac Shakur 2pac Shakur is offline
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Default One large trader led to May 6 stock market plunge

WASHINGTON (AP) -- A trading firm's use of a computer sell order triggered the May 6 market plunge, which sent the Dow Jones industrial average plunging nearly 1,000 points in less than a half-hour, federal regulators said Friday.

A report by the Securities and Exchange Commission and the Commodity Futures Trading Commission determined that the so-called "flash crash" occurred when the trading firm executed a computerized selling program in an already stressed market.

The firm's trade, worth $4.1 billion, led to a chain of events the ended with market players swiftly pulling their money from stock market, the report said.

The report does not name the trading firm. But only one trade that day fit the description in the report. The firm Waddell & Reed, based in Overland Park, Kan., has acknowledged making such a trade that day.

I call BS (not Black-Scholes).
Also, if it were true, wouldn't that violate the assumptions of the CAPM?

Assumptions of CAPM

All investors:
Aim to maximize economic utilities.
Are rational and risk-averse.
Are broadly diversified across a range of investments.
Are price takers, i.e., they cannot influence prices.
Can lend and borrow unlimited amounts under the risk free rate of interest.
Trade without transaction or taxation costs.
Deal with securities that are all highly divisible into small parcels.
Assume all information is available at the same time to all investors.
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Old 10-01-2010, 04:08 PM
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Unholy Passion Unholy Passion is offline
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pretty sure CAPM has been considered to be garbage for quite some time now (Roll's Critique, for one thing)

APT (arbitrage pricing theory) does a better job
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Old 10-01-2010, 05:18 PM
axjoke axjoke is offline
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Pulled from ZH:

"Futures and options markets are hedging and risk transfer markets. The report references a series of bona fide hedging transactions, totaling 75,000 contracts, entered into by an institutional asset manager to hedge a portion of the risk in its $75 billion investment portfolio in response to global economic events and the fundamentally deteriorating market conditions that day. The 75,000 contracts represented 1.3% of the total E-Mini volume of 5.7 million contracts on May 6 and less than 9% of the volume during the time period in which the orders were executed. The prevailing market sentiment was evident well before these orders were placed, and the orders, as well as the manner in which they were entered, were both legitimate and consistent with market practices. These hedging orders were entered in relatively small quantities and in a manner designed to dynamically adapt to market liquidity by participating in a target percentage of 9% of the volume executed in the market. As a result of the significant volumes traded in the market, the hedge was completed in approximately twenty minutes, with more than half of the participant's volume executed as the market rallied – not as the market declined. Additionally, the aggregate size of this participant's orders was not known to other market participants.

Additionally, the most precipitous period of market decline in the E-Mini S&P 500 futures on May 6 occurred during the 3½ minute period immediately preceding the market bottom that was established at 13:45:28. During that period, the participant hedging its portfolio represented less than 5% of the total volume of sales in the market. "
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Old 10-01-2010, 05:28 PM
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twig93 twig93 is offline
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If you put in a sell order worth $4.1 billion, it is not reasonable to assume that you won't influence the price of the stock.
Originally Posted by Gandalf
The thing that is clearest is twig's advice
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Old 10-01-2010, 05:32 PM
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Gonzo Gonzo is offline
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how large was this trader? was he > 300 lbs?
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Old 10-01-2010, 05:40 PM
axjoke axjoke is offline
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Originally Posted by twig93 View Post
If you put in a sell order worth $4.1 billion, it is not reasonable to assume that you won't influence the price of the stock.
I don't think it was put in all at once. Sounds like it was a program trade that broke it up into pieces and was set to keep the firms volume share at a fraction of the actual underlying trade volume.

Have they even stopped the flash orders yet? I still get half filled XX.00001 and XY.99999 trades a ton when I try to move a position across accounts during market hours (pre/post market it works fine).

Last edited by axjoke; 10-01-2010 at 05:47 PM..
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Old 10-01-2010, 05:48 PM
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ElDucky ElDucky is offline
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Originally Posted by Gonzo View Post
how large was this trader? was he > 300 lbs?
If you converted $4.1 billion into popcorn shrimp, that's how large he was.
I live near the cows.
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Old 10-05-2010, 11:31 AM
axjoke axjoke is offline
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From the Big Picture:

The Internalizers and The Flash Crash; Let’s Talk Real Villains

By Barry Ritholtz - October 5th, 2010, 7:00AM Sal Arnuk

Themis Trading LLC
10 Town Square, Suite 100
Chatham, NJ 07928


By now every world citizen who has ever owned any stock knows “Waddell” as a household word. The regulators do not name them specifically in their October 1st SEC/CFTC Flash Crash Report (available here), yet the firm’s identity might just top the world’s worst-kept-secret list. If there were not enough references to Waddell and Reed over the weekend on Twitter and thousands of blogs, Dave Cummings, owner the HFT powerhouse Tradebot may have rectified that with his letter to the street, titled “Waddell Stupidity Caused The Crash” (available here).

Waddell is blamed for unleashing an algorithmic percentage-of-volume order to sell 75,000 E-Minis that everyone seems to be crediting for the Flash Crash. Don’t take the bait. This is as good a diversion, and example of misdirection, as we have ever seen. Consider the following:

- 35,000 contracts were sold on the ways down; 40,000 were sold on the rebound after the CME’s 5 second trading pause. This should be pointed out as everyone is citing 75,000 contracts (the total).

- It was 9% of the volume while it was active (during the period about 833,000 contracts traded.

- S&P E-Minis are among the world’s most liquid instruments.

We are saddened that nowhere in the public discussion is the role that internalization firms (OTC Market Makers) played in the day’s unraveling. Internalizers, a term the SEC is using in its Flash Crash Report, handle individual investor retail market orders. (For example, you can look on Ameritrade’s 606 report for Q2 2010, and see that 83% of market orders are sold to Citadel for about .0015/share on average.)

Typically, the internalizer then takes the other side of the trade for “a very large percentage” of this flow. On May 6th, the SEC found that there was a departure from this practice (see page 58 of the SEC Report). As the market was falling dramatically, the internalizers (we don’t know which internalization firms the SEC is referring to) continued to short stock to retail market buy orders, but they dramatically stopped internalizing retail market sell orders, and instead flooded the public market with those orders. When the market stopped falling, and rose dramatically almost as quickly as it fell, the internalizers reversed that pattern, and internalized retail sell market orders, and flooded the public market with retail market buy orders. To restate this plainly, the internalizers used their speed advantages to pick and choose for its P/L which orders it wanted to take the other side of. For the ones they did not wish to take the other side of, they routed them to the markets as riskless-principal trades. The practice not only strikes us as patently unfair, but the number of orders that flooded the marketplace was massive. As such it caused data integrity issues (widening the difference between speeds of the CQS public data and the co-located data), further perpetuating the downward cycle in the marketplace.

In addition, we point out the SEC‘s findings on page 65, as they discuss broken trades, and the large amount attributed to internalizer:

“Many internalizers of retail order flow stopped executing as principal for their customers that afternoon, and instead sent orders to the exchanges, putting further pressure on the liquidity that remained in those venues. Many trades that originated from retail customers as stop-loss orders or market orders were converted to limit orders by internalizers prior to routing to the exchanges for execution. If that limit order could not be filled because the market continued to fall, then the internalizer set a new lower limit price and resubmitted the order, following the price down and eventually reaching unrealistically-low bids. Since internalizers were trading as riskless principal, many of these orders were marked as short even though the ultimate retail seller was not necessarily short. This partly helps explain the data in Table 7 of the Preliminary Report in which we had found that 70-90% of all trades executed at less than five cents were marked short.

Furthermore, in total, data show that internalizers were the sellers for almost half of all broken trade share volume. Given that internalizers generally process and route retail trading interest, this suggests that at least half of all broken trade share volume was due to retail customer sell orders.”

Even more disturbing was this:

“Detailed analysis of trade and order data revealed that one large internalizer (as a seller) and one large market maker (as a buyer) were party to over 50% of the share volume of broken trades, and for more than half of this volume they were counterparties to each other (i.e., 25% of the broken trade share volume was between this particular seller and buyer.”

Since we all know the name of Waddell, shouldn’t we also know the name of the ONE market maker and the ONE internalizer who were responsible for more than 50% of the volume of broken trades?

Retail investors were clearly the biggest loser on May 6th. They trusted that their brokers would execute their orders in a fair and efficient manner. However, considering that half of all broken trades were retail trades, and that the arbitrary cutoff was 60% away from pre flash crash levels, the retail investor ended up paying the highest price for the structural failings of our market.
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