The Flash Crash, a phenomenon on the rise in recent years, has a primary cause not usually considered by most operators.
The phenomenon of "Flash Crash", not to be confused with the more complex mechanism of "Panic Selling", is an increasing phenomenon over the last few years. The dynamics are very similar to each other, with very strong market collapses but which have a certainly different duration over time.
The Flash Crash is a situation that frightens operators and only those who have witnessed a Flash Crash live can know what the feeling is of seeing market fluctuations that, in fact, are not comparable to Panic Selling, nor to normal collapses.
The Flash Crash is a particular market situation that deserves to be clarified to better understand how the market, albeit under normal conditions, could react in certain situations. So let’s see now what a Flash Crash is, also making some “historical” examples.
What is a "Flash Crash"
The "Flash Crash" is literally translatable as "Lightning Crash": it is a drop in prices very fast and almost instantaneous, if we compare the amplitude of the movement with the time span taken into account.
Usually the movement from Flash Crash, in particular conditions, is accompanied by a recovery phase that takes place in the very short term. The first feeling you have in front of a Flash Crash is that of "powerlessness" towards what is happening to the market, as the movement is so strong that you are essentially stuck in trading. The Flash Crash, in fact, is easily ascribable to a shock, in which the immobility is due precisely to the strong emotional component that shakes those who observe the market at that moment.
Making evaluations in this area is possible only thanks to a good emotional detachment, "normal" in professionals in the sector, and only if one senses, through previous analyzes, where the market will bounce. In summary, only for those who have a real operational plan that avoids entering the market in situations of this kind. The danger of Flash Crash is incredible, perhaps worse than Panic Selling situations. Let us now look at a historical example.
The Flash Crash of 2010
A collapse of 9% in about 20 minutes of trading: this is what happened on May 6, 2010 in the American market, a collapse so strong that it involved all sectors of the financial market, from the stock market to future options and to ETFs, i.e. all instruments linked precisely to the performance of the stock market. The 9% collapse occurred between 2:42 pm and 3:07 pm New York time, while the recovery over the next two hours led the market to close with an average loss of 3%. In essence, the market collapsed by 9% and then recovered 6% in a few hours from the lows, an excellent recovery considering the very strong decline.
Initially, the causes were attributable to the bad news that had spread about the Greek crisis and the euro zone, so much so that the futures of the American stock market were already negative in the European morning. The Sec and the Cftc, the control bodies on stock exchange trading in the US, have not found a single cause or only one responsible. Among the possible causes: the sell order of a very important trader who would have sold short about 75000 contracts of E-Mini S&P (the futures contract on the S & P500 index), hedging the risk of an already bullish position. outstanding with an equivalent value of $4 billion; an autistic trader attributable to a London prop trading company who, from his bedroom, allegedly caused the crash through the use of trading systems; and a trader who earned around $ 40 million between 2009 and 2015 (and therefore even after the crash).
In practice, causing a Flash Crash is a set of contingent causes, which however depend on a single primary cause. Let’s see which one.
The root cause of a Flash Crash
The primary cause of a Flash Crash lies in the so-called "Market Vacuum", ie the lack of a significant share of buyers at different price levels, below the current market price. It is no coincidence that the Flash Crash occurs in situations where the market has usually already taken its bearish path, at least in the short term.
Let’s take an example: imagine that the market is "full" of sellers, that is, with a clear supremacy of sellers over buyers. If the presence remains majority, when the buyers finish a market crash begins for a few levels, untilnew buyers are found. If the new buyers are not present for price levels even technically invalid, here is that buying becomes a gamble and the real Flash Crash is unleashed, i.e. a situation where sellers push the price down and where almost no one succeeds to exchange. Basically, a real market vacuum is created.
The other causes, namely those attributable to cases of "fat fingers", traders who place heavy market orders for sale, are to be considered initiators of the Flash Crash process.
The case of the pound flash crash that occurred on the night of 26 September 2022 is the prime example of the above: with a huge market gap, the Flash Crash on a European market at 2:30 am is perfectly normal. Obviously, complicit in these movements, there must be a technical situation that is predisposed to these events, be they historical highs or, as in the case of the pound, historical lows.
Original article published on Money.it Italy 2022-09-27 08:58:00. Original title: Trading, cos’è il Flash Crash
