I. Causes ~ Negative news + quote saturation + large (coordinated?) instantaneous sale leads to delayed price data.

Negative News

The Greek Parliament's approval of austerity measures to avert debt default, triggered riots in Athens, which led to speculation and fear that it would ignite a string of defaults across Europe and the rest of the world. The riots in Athens aired live on CNBC at the start of our summary chart.  The scaling to the left of the link indicates the elapsed time shown in the video that matches the time in our chart: an elapsed time of 4:50 in the video lines up with 14:44 on our chart (the label 3m indicates the 3 minute elapsed time block).

Sale of eMini Futures and ETFs (see items 2 and 3 on main chart and Inset)

It appears that the event that sparked the rapid sell off at 14:42:44:075 was an immediate sale of approximately $125 million worth of June 2010 CME eMini futures contracts and at the same time the immediate sale of over $100 million worth of the top ETF's such as SPY, DIA, QQQQ, IVV, IWM, SDS, XLE, and EEM. Both the eMini and ETF sales were sudden and executed at prevailing bid prices. The orders appeared to hit the bids.

Quote Saturation (see item 1 on chart)

Approximately 400ms before the eMini sale, the quote traffic rate for all NYSE, NYSE Arca, and Nasdaq stocks surged to saturation levels within 75ms. This is a new and surprising discovery. Previouisly, when we looked at time frames below 1 second, we thought the increase in quote traffic coincided with the heavy sales, but we now know that the surge in quotes preceded the trades by about 400ms. The discovery is surprising, because nearly all the trades in the eMini and ETFs occurred at prevailing bid prices (a liquidity removing event).

While searching previous days for similarities to the time period at the start of the May 6th drop, we found a very close match starting at 11:27:46.100 on April 28, 2010 -- just a week and a day before May 6th. We observed it had the same pattern -- high, saturating quote traffic, then approximately 500ms later a sudden burst of trades on the eMini and the top ETF's at the prevailing bid prices, leading to a delay in the NYSE quote and a sudden collapse in prices. The drop only lasted a minute, but the parallels between the start of the drop and the one on May 6th are many. Details on April 28, 2010

The quote traffic surged again during the ETF sell event and remained at saturation levels for nearly 500ms. Additional selling waves began seconds later sending quote traffic rates back to saturation levels. This tidal wave of data caused delays in many feed processing systems and networks. We discovered two notable delays: the NYSE network that feeds into CQS (the "NYSE-CQS Delay"), and the calculation and dissemination of the Dow Jones Indexes (DOW Delay).

NYSE-CQS Delay

The delay of NYSE's quote to the CQS system has been covered extensively in our original and subsequent reports. However, there is one new piece of information which shows that some NYSE stocks were delayed more (24 seconds) than others (5 seconds). We found that stocks beginning with the letters A through M (except for I and J) were delayed up to 24 seconds, while stocks beginning with I, J, and N through Z were delayed up to approximately 5 seconds.

DOW Delay

There were two separate delays in the Dow Jones Indexes (the Dow Industrial Average, symbol DJI, is shown in the main chart). The first delay arises from the delay in the input data (NYSE-CQS delay) and the methodology used by Dow Jones in computing DJI - they only use prices of trades from the NYSE for NYSE component stocks.

A second and larger delay appears to originate within the feed processors that compute the index values. To find the second delay, we calculated DJI using the same methodology as Dow Jones and compared the result to the value disseminated in the feed. Our prices during the periods prior to and shortly after the crash matched the prices disseminated by Dow Jones; however, during the crash, we noticed significant delays. We confirmed the prices of DJI in the feed matched or were ahead of other sources.

Financial news programs primarily used the Dow Jones Index to convey to their audience the state of the market during the Flash Crash.

II. Effects ~ Delayed price data leads to uncertainty, fear, and panic.

Stub Quotes

The main chart shows when significant stub quote trades occurred (light blue dots) and the relative intensity of stub quote trades in the Stub Trades color ribbon.

Other reports point to Stub Quotes as a factor in the Flash Crash. This is not supported by the data.  Nearly all Stub Quote Trades, which are trades executed at stub quotes, occur after the market bottomed and therefore stub quotes could not have been a cause of the crash.

Stub quote trades may have been the result of a combination of a lack of liquidity and panic induced market orders based on delayed quote data.  People watching television news sources showing the plunging Dow Index (which we now know was delayed 2+ minutes) may have been one source of stub quote trades. Also, the triggering of stop loss orders, which become market orders when hit, may have resulted in stub quote trades.

However, it is interesting to note that a significant number of stub quote trades appear immediately after the perceived bottom of the market -- when the very much delayed Dow Index makes it's low. In fact, for those with timely quote data,  the market was actually rocketing higher when nearly all stub quote trades executed.

NYSE Slow Mode or Liquidity Replenishment Points (LRPs)

The NYSE employs a circuit breaker known as the Liquidity Replenishment Point or LRP. Each NYSE stock has a LRP which is essentially a predetermined price above and below the trade price of that stock. If the price of a trade in that stock exceeds the upper or lower LRP price, software at the NYSE automatically turns off NYSE's auto-execution system and places the stock in Slow Quote Mode, which means it's handled differently by that stock's Designated Market Maker.

When an LRP is triggered, the NYSE will send out a quote with a special tag indicating that stock is now in Slow Quote Mode. That quote is sent out the same way that other quotes are disseminated, which means if the quotation system is overloaded and delayed (recall the NYSE-CQS Delay), the quote with the special tag will be delayed too. This means a lot of orders can get sent between the time the switchover to LRP mode occurs on the NYSE floor and the reception of the quote indicating the switchover occurred.

We have noticed that trade executions in a stock immediately after it hits an LRP are often at substantially lower prices than bid prices on other markets. It was this reason why we began our flash crash by first investigating LRP's role in the flash crash.  However we found that the number of stocks switching to Slow Mode did not become significant until well after the market had already bottomed.

Anemic Recovery Volume

The Trade Rate color ribbon shows trading activity first surged at 14:42:44 (bright red), again at 14:43:20, 14:43:45, 14:44:05, and then at 14:44:30 and remained high until about 14:46:20, where it began slowing considerably (changing to green and cyan) and except for a brief surge ar 14:49:25, remained low. The Quote Rate ribbon (directly above the Trade Rate ribbon) shows a strong correlation and also begins to slow around 14:46:20 (note this is also about the same time the NYSE-CQS Delay peaked).

This drop in quote and trading volume also occurs shortly after the market bottomed (though the perceived bottom for those using the DJI as a proxy, would not come for another 40 seconds at 14:47).  Yet prices of stocks rocketed higher. By 14:48, the SPY, and many other stocks, had regained all they had lost from the drop at 14:42:44 and on significantly lower volume.

Applying simple supply and demand logic to these events might suggest the recovery was not driven by stong demand, but rather a lack of supply; perhaps there were few sellers left.

Large eMini Futures Discount (ES.M10 - SPY)

Beginning at 14:46:35  the difference between the price of the SPY equity and the eMini futures contract grew to about 3% at 14:48:50, and returned to normal at 14:50:40. A considerable arbitrage opportunity, selling SPY and buying the future contract, existed for nearly 4 minutes. Some of this difference could have been due to the Waddell 75,000 contract eMini sell program that reportedly took place between 14:32 and 14:52.

III. Further Research

Here are some ideas for further research. Nanex does not have access to brokerage account data and, therefore cannot research those questions requiring such access.

1. Were the sales of eMini's and ETF's at 14:42:44.075 coordinated?

2. Were the quotes that occurred prior to the eMini/ETF sales (in question 1) coordinated?

3. Were the initial sales and quotes on 4/28 also coordinated?

4. Can the initial events of 4/28 and 5/6 be tied together?

5. Why did what appears to have been a very profitable SPY/eMini Futures arbitrage opportunity, go unexploited for almost 4 minutes? Were there too few traders with quote data deemed reliable enough to execute the strategy?

6. Could the peak in the NYSE-CQS quote delay have been an indication that many trading systems and networks were stressed to the point of collapse?  Is that why the quote and trade rates dropped off and remained low for the rest of the recovery?

7. Further investigate the 'flickering quote' exception of Reg NMS Rule 611 and how it might relate to many of the sequences we see here.

IV. Recommendations

In our original flash crash report, we made 3 simple and straightforward recommendations. We've clarified and reduced them down to 2 (a rule banning quote stuffing is not required because the minimum quote life rule would effectively stop this practice):

1. Replace the existing time stamp in consolidated quotation feeds with one generated immediately before that data becomes available to any system.

2. Add a minimum quote life rule, whereby a quote must remain active until executed, improved, or a specific amount of time (50ms) elapses.

A minimum quote life rule has far less chance for unintended consequences, because as early as 5 years ago, it was essentially in force due to the limits of technology at that time. This chart shows a conservative estimate of the amount of quotes that would have been eliminated if the minimum quote life rule was 50ms. We believe the reduction in quote traffic from this rule would have prevented quote delays, making access to this data more fair to everyone.

Alternative Recommendations

Alternative 1:

Require  exchanges to route orders based on data from the Security Information Processor or SIP (e.g. CQS/CTS, UQDF/UTDF). This would level the playing field and provide a much better audit trail for determining if a trade received the best possible prices. Currently, each exchange essentially must recreate their own internal SIP in order to determine whether to route an order. The data from this internal SIP is not available (as far as we can tell) from any exchange. We created a video of an application we wrote that illustrates exchange routing and the separate internal SIP.

Alternative 2:

Ban exchanges from providing direct feeds that contain core quote and trade information. Current regulations (Reg NMS, rule 603(a)) prohibits direct exchange feeds from transmitting data this core data to a vendor any sooner than it transmits the data to a Network processor (e.g. CQS).

Finally, we think a solution exists without new rules and regulations: if only the SEC would enforce, or at the very least provide guidance to, existing rules and regulations.