Flash crash questions linger a year after plunge

By Mark Jewell AP Personal Finance Writer BOSTON (AP) -- Sometimes it's easy for investors to lose perspective. The stock market "flash crash" of May 6, 2010 was just such an occasion. The nearly 600-point drop of the Dow Jones industrial average in roughly five minutes had little impact on the vast majority of investors. It amounted to the blink of an eye relative to the decades needed to save for retirement. By that day's closing bell, the market partially recovered, finishing down 347 points. Ultimately about 21,000 trades were deemed erroneous and canceled. The event was largely imperceptible to investors in mutual funds, which are priced once a day at the close. Still, the crash was scary. The chief source of fear that morning was the debt crisis in Greece. The major indexes were already down when it became apparent that the market wasn't working properly. How else to explain shares of Procter & Gamble falling from $60 to $40 in less than four minutes, only to rebound a minute later? Such swings led to the brief loss of $1 trillion in value across the market. Regulators and stock exchanges are trying to prevent a recurrence. They've put circuit breakers in place temporarily to briefly halt trading of certain big stocks that veer wildly. The Securities and Exchange Commission is considering longer-term requirements that would bar any trades outside a specified price range. Meanwhile, there hasn't been a comparable stock market glitch over the past year, and volatility has eased. Trading volume is down, including high-frequency computer-driven trading that may have triggered the flash crash. SEC Chairwoman Mary Schapiro told reporters on Wednesday that much has been done to fix the system, but more work remains: "Can I guarantee that we'll never have another flash crash? No." The Associated Press interviewed two finance professors who have studied the flash crash and written about market vulnerabilities. Georgetown University's Jim Angel and the University of Maryland's Albert "Pete" Kyle also spoke at a Georgetown conference last Thursday on lessons one year after. Excerpts from the interviews: Q: How do you explain the flash crash of 2010? ANGEL: There were really two events on May 6, 2010: The dip in the price of the S&P 500 futures contracts known as the 'E-mini', and the related dip in prices of S&P 500 stocks. The first event was apparently triggered by one very large order from a traditional money manager. Normally, the market would have digested that order without trouble. But the market was so jittery over the situation in Greece that prices plummeted momentarily. Many of the normal price stabilizers -- the people whose computers monitor prices from millisecond to millisecond -- stopped trading because they were experiencing data integrity problems. They just didn't believe the numbers they were seeing, in part because their different data feeds were giving them different numbers. So they did the prudent thing and stepped aside for a few minutes until they figured out what was happening. While the normal stabilizers stepped aside, there were other traders who were paying less attention and who continued to sell even as prices were plummeting. This resulted in a few egregious erroneous trades such as Accenture at a penny, and Sotheby's at nearly $100,000. Q: There's been lots of flash-crash finger-pointing at computerized trading. Ultimately was technology to blame? ANGEL: Glitches are inevitable in any complex technological system. Our markets are now much better, faster, and cheaper than ever before, but sometimes technology breaks. Think of the difference between a manual typewriter and a word processor: Sometimes our computers glitch in ways that the old typewriter didn't, but we wouldn't dream of going back to the old typewriter. Q: Has computer-driven high-frequency trading rigged the system against small investors? KYLE: Computers have actually made markets better. It's the fragmentation, not the computers, that has made stocks behave in such a strange manner. You've got many exchanges to trade stocks on now, rather than just a handful. I don't think the high-frequency traders make the whole market go up and down. They just grab pennies by using automated systems to profit from split-second stock movements. They're not driving the entire market steamroller. Q: What do you think of the regulatory response to the flash crash? ANGEL: The SEC has taken lots of steps to ensure that the damage is contained when a glitch occurs, such as the use of circuit breakers, and to make sure that the technological infrastructure is robust. The problem is that the SEC is under-budgeted, and has trouble getting and keeping enough good people to do the job right. They are also located far away from the financial markets, and they don't oversee all the moving parts in our modern market. Q: Any flash crash-related advice for average investors? ANGEL: Never place a stop-loss order (sets the price at which a stock is automatically sold when it declines to a specified level.). They are a great way to sell out at the bottom. Such orders may get triggered by a momentary glitch in prices. Even without a glitch in the market, there's roughly a 50 percent chance when the stock hits your stop price that it will bounce up from that price, meaning you have sold at the bottom. KYLE: The flash crash should have been imperceptible to most individual investors. You shouldn't care what happens between noon and 3 p.m. in the stock market, because it's not relevant to you. You should be a long-term investor, and always trade with a strategy of buying things if they get cheap, and selling when they get expensive. Or, just buy and hold. Q: Seventy percent of the questionable trades that ended up being canceled involved ETFs. Does that mean average investors should stay away? KYLE: No. Investors shouldn't be shaken by a flash crash affecting an ETF. If they are, it probably means they're taking too short-term of a focus in their investing strategy, and they need to think longer-term. ETFs are alternatives to index funds. For investors, taking a long-term position in an index fund is probably a good way to save for retirement. You don't really need the ETF, because they're designed in part for trading actively, and average investors shouldn't do that. ---------------- AP Business Writer Marcy Gordon contributed to this report from Washington. Questions? E-mail the AP at investorinsight@ap.org. Published: Mon, May 9, 2011