Nanex ~ 26-Mar-2013 ~ Flash Crash Mystery Solved

• processing trillions of exchange quote, trade and order book records for stocks, options, and futures on May 6th and other trading days back to 2005 and days since.
• matching up the actual 6,438 trades (75,000 contracts) executed by Barclays for Waddell & Reed to the 147,577 trades executed in the CME June 2010 eMini during that time.
• drawing from extensive interviews with authors of academic and regulatory papers on the Flash Crash.
• conversations with dozens of traders, programmers, investigative jouralists, government officials in the U.S. and abroad, anonymous callers, and "people familiar with the matter" since June 2010.
• finding and studying similar crashes in the eMini and crude oil and thousands of other anomalies.

High Frequency Trading caused the Flash Crash. Of this, we are sure.

..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.

• Always ask for data used to back up any claim. You will find a lot of people are long on talk, woefully short on data. Data is difficult to obtain and takes a lot of expertise to work with: use that to separate the wheat from the chaff.
• The SEC publicly stated numerous times that it took them 5 months just to receive and organize the vast amount of market data. 5 months from May 6th is October 6th, yet they published their report on October 1st. When did they have any time for analysis?
• W&R used Barclays to execute the algo (a fact not mentioned in any SEC report).
• The regulators (CFTC) first interviewed the Barclay team that executed the W&R trades on October 14, 2010 - yet published the final flash crash report 2 weeks earlier, on October 1, 2010. Why this has never been mentioned in the media is a mystery.
• Barclay's algo was passive, it never crossed the bid-ask spread during the crash. This type of passive algorithm cannot cause a market crash on its own.
• Barclay's algo only sold about 1000 contracts during the entire 600 point slide in the DJIA. It did not accelerate selling as the market began to drop. To claim otherwise is simply untrue.
• Barclay's algo sold heavily after the eMini circuit breaker ended and the market had bottom: a period of maximum chaos, severely delayed feeds and minimum liquidity. Yet market prices climbed.
• The SEC final flash crash report incorrectly uses the word liquidity 249 times in 89 pages. It is worthwhile reading about this monumental logic error.
• Barclay's and W&R gave the actual trade executions to Nanex for analysis and we were able to match up those trades to the CME time and sales so we have a true and accurate picture of how the algo executed. We know exactly which trades came from W&R and an exact picture of how the market looked when each one executed.