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The SEC/CFTC (Securities and Exchange Commission/ Commodity Futures Trading Commission) investigation to uncover what caused the flash crash took rather longer than many Street-watchers had expected. Suddenly everyone had heard of 'high frequency trading' and Wall Street's financial finest detectives competed to become known as the 'Sherlock Homes of the stock market' but now it seems, the mystery is no more. Or is it?

It turns out that a single trader caused all the mayhem on a day when markets were feeling somewhat delicate, partially thanks to worries over the state of Greece's economic woes.

The joint SEC/CFTC report said that, "Against a backdrop of negative market sentiment and thinning liquidity, at 2:32 p.m., a large Fundamental Seller (a mutual fund complex) initiated a programme to sell a total of 75,000 E-Mini contracts (valued at approximately $4.1 billion) as a hedge to an existing equity position.

"This large Fundamental Seller chose to execute this sell programme via an automated execution algorithm ('Sell Algorithm') that was programmed to feed orders into the June 2010 E-Mini market to target an execution rate set to nine per cent of the trading volume calculated over the previous minute, but without regard to price or time.

"The execution of this sell programme resulted in the largest net change in daily position of any trader in the E-Mini since the beginning of the year (from 1 January 2010 through 6 May 2010). Only two single-day sell programmes of equal or larger size - one of which was by the same large Fundamental Seller - were executed in the E-Mini in the 12 months prior to 6 May. When executing the previous sell programme, this large Fundamental Seller utilised a combination of manual trading entered over the course of a day and several automated execution algorithms which took into account price, time, and volume. On that occasion it took more than five hours for this large trader to execute the first 75,000 contracts of a large sell programme."

BATTLING ROBOTS It has been widely reported that the mutual fund which allegedly caused the dive in the Dow belonged to Waddell & Reed Financial, although a number of people have dismissed the allegations with Nanex, a US research company pointing out that Waddell's trades took place after the DJIA had hit the bottom and therefore could not have caused the crash. The Wall Street Journal has pointed out that the algorithm was supplied by Barclays Capital, although there was no word from BarCap on what happened.

The SEC/CFTC, however, has stuck to its guns and has highlighted the difference between the human traders and the high speed automated algorithms and how humans could not match their electronic colleagues.

"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 10-fold increase in volume that occurred as prices in many securities rapidly declined," the SEC/CFTC report said.

The SEC and CFTC have embarked on implementing a circuit breaker programme in an attempt to prevent a reoccurrence of such events, if a market dives by more than 10 per cent in five minutes.

2009 CPI Financial. All rights reserved.

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Publication:Banker Middle East
Geographic Code:4EUGR
Date:Dec 1, 2010
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