Flash Crash Mystery Solved

[MachineGhost]

..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.

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