Investigation Into Flash-Crash Continues

While the cause of the so-called Wall Street “flash crash” on May 6 this year has not yet been confirmed by regulators charged with investigating the incident, it is likely to lead to a tougher stance on controlling who has access to high-frequency trading on markets. The investigation includes scrutinizing brokers suspected of failing to thoroughly check high-frequency traders before allowing them market access, which raises a whole host of concerns, especially in light of the fact that around 60 percent of US trading volumes take place electronically. With brokers being in the position to grant traders direct access to run algorithms, the responsibility rests with brokers to ensure that they know exactly who they are granting access to, and those found to be negligent in this regard face the very real possibility of hefty fines.

On May 6, the markets started down and continued to slide, mainly in response to Europe’s alarming debt crisis. After a dramatic intra-day drop of nearly 1,000 points, markets recovered somewhat, leaving Wall Street traders shell-shocked and confused as to what had happened and, more importantly, why? As the investigation continues, speculation and conspiracy theories are rife. Financial Industry Regulatory Authority (FINRA) chairman and CEO, Richard Ketchum, has been reported as saying that FINRA is “looking to find out if the brokers understood what was being done with the algorithm, and whether the high-frequency trader had thought through how it would work under big market changes”. If it is established that high-frequency traders were responsible for the flash-crash, then it may be that some were unqualified to be playing in the high-stakes field of electronic trading and the incident can be chalked up to ignorance or human error, or it could be that the system simply became overloaded and went haywire, which needs to be addressed. Some are of the opinion, however, that something more sinister was going on.

Analysts at Chicago-based firm, Nanex, have offered the possibility that the flash-crash may have been caused by a group of high-frequency traders trying to out-run and outwit opposition traders with a flurry of orders that were not necessarily legitimate, but were intended to introduce delays in the system to be used to their advantage. Whether this can be proved or not, remains to be seen, but until the cause of the flash-crash is confirmed, there is no guarantee that it won’t happen again.