Monday, May 10, 2010

Markets don’t work!

OK, I really don’t believe that and actually think that markets can be used in virtually all situations if properly designed and market forces are harnessed correctly.

However, last Thursday for about 10 minutes, at 7.45pm our time, the New York Stock Exchange did not work.  This fed to other exchanges. In a few manic minutes the DJIA fell about 900 points or about 10%.  There was little that could explain the precipitous drop.

Here is the few minutes as they played out on CNBC.  This is one instance in which the irritating Jim Cramer seems to have been right on the money.

While there obviously was a stroke of luck that they put up the Procter & Gamble chart, there were other stocks that had even more dramatic falls.  Some stocks that were trading at between $40 and $60 at 7.45pm fell to a fraction of a cent for a few seconds. See here.

The major exchanges came out later that day and said that trades that resulted in a move of more than 60% of the value of the share would be cancelled.  Owners of shares on the list linked above that sold for 0.1 of a cent were undoubtedly pleased with that.  With P&G falling by ‘only’ 30%, the trades that caused the swings in the above clip stand.  As Cramer said a few lucky people are after making a lot of money very quickly.

Although not official yet it seems likely the drop was caused by automated selling rules that kicked once a particular level is broken.  If a few major institutional investors have the same automated rule in place the market can become flooded with sell offers, that swamp the few bid offers that exist. 

The automated sell trades looked for buyers at any level and probably found at few automated bid offers at ridiculous low levels.  A trader who had bid offers inputted at very low levels suddenly struck it lucky.  On 99.99% of days these low-ball offers would be ignored.  Last Thursday was the 0.01% of days when the machines went haywire and those one-a-million prices came up – if only for a few seconds.  Pretty quickly the traders would have seen what was happening (though probably not understood it) and would override the automatic trades.  By then the damage was done.

Maybe a few of them should buy this t-shirt.

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