Flash Crash report part 7
LIQUIDITY CRISIS WITH RESPECT TO INDIVIDUAL STOCKS
The second liquidity crisis occurred in the equities markets at about 2:45 p.m. Based on
interviews with a variety of large market participants, automated trading systems used by
many liquidity providers temporarily paused in reaction to the sudden price declines observed
during the first liquidity crisis. These built-in pauses are designed to prevent automated
systems from trading when prices move beyond pre-defined thresholds in order to allow
traders and risk managers to fully assess market conditions before trading is resumed.
After their trading systems were automatically paused, individual market participants had to
assess the risks associated with continuing their trading. Participants reported that these
assessments included the following factors: whether observed severe price moves could be an
artifact of erroneous data; the impact of such moves on risk and position limits; impacts on
intraday profit and loss (“P&L”); the potential for trades to be broken, leaving their firms
inadvertently long or short on one side of the market; and the ability of their systems to
handle the very high volume of trades and orders they were processing that day. In addition, a
number of participants reported that because prices simultaneously fell across many types of securities,
they feared the occurrence of a cataclysmic event of which they were not yet aware,
and that their strategies were not designed to handle.
Based on their respective individual risk assessments, some market makers and other liquidity
providers widened their quote spreads, others reduced offered liquidity, and a significant
number withdrew completely from the markets. Some fell back to manual trading but had to
limit their focus to only a subset of securities as they were not able to keep up with the nearly
ten-fold increase in volume that occurred as prices in many securities rapidly declined.
HFTs in the equity markets, who normally both provide and take liquidity as part of their
strategies, traded proportionally more as volume increased, and overall were net sellers in the
rapidly declining broad market along with most other participants. Some of these firms
continued to trade as the broad indices began to recover and individual securities started to
experience severe price dislocations, whereas others reduced or halted trading completely.
Many over-the-counter (“OTC”) market makers who would otherwise internally execute as
principal a significant fraction of the buy and sell orders they receive from retail customers
(i.e., “internalizers”) began routing most, if not all, of these orders directly to the public
exchanges where they competed with other orders for immediately available, but dwindling,
liquidity.
Even though after 2:45 p.m. prices in the E-Mini and SPY were recovering from their severe
declines, sell orders placed for some individual securities and ETFs (including many retail stoploss
orders, triggered by declines in prices of those securities) found reduced buying interest,
which led to further price declines in those securities.
Between 2:40 p.m. and 3:00 p.m., approximately 2 billion shares traded with a total volume
exceeding $56 billion. Over 98% of all shares were executed at prices within 10% of
their 2:40 p.m. value. However, as liquidity completely evaporated in a number of individual
securities and ETFs,11 participants instructed to sell (or buy) at the market found no
immediately available buy interest (or sell interest) resulting in trades being executed at
irrational prices as low as one penny or as high as $100,000. These trades occurred as a result of
so-called stub quotes, which are quotes generated by market makers (or the exchanges on their
behalf) at levels far away from the current market in order to fulfill continuous two-sided
quoting obligations even when a market maker has withdrawn from active trading. |
