Flash Crash Analysis

http://www.nanex.net/20100506/FlashCrashAnalysis_Intro.html

This came out about 6 weeks after the flash crash. The analysis is as good, if not better, than anything that's come out since then. This includes the recent SEC statement/report that supports the "fat-pinky" theory (reference http://www.reuters.com/article/idUSN3013208820100930). Larry Levin summarizes this statement as "nonsensical drivel" (reference http://www.secretsoftraders.com/stocks/sec-nonsense-241623)

To summarize, many of the HFT (high-frequency trading) shops look for the same buy/sell signals, often in the form of flash trades (cross-exchange orders that seek to exploit price differentials). Usually, competitiveness among HFTs maintains a sort of balance, promotes efficient price discovery,
and provides 30%-70% of total market liquidity. However, on May 6, there was a confluence of circumstances that caused these HFTs to exert an usual amount of selling pressure, which initially drove price down. When they realized that market conditions had become abnormal (i.e., their systems
were either generating unsuitable signals or receiving inaccurate data), they logically shut their systems down, but with the result that much market liquidity disappeared (albeit briefly), thus inciting a wider panic.

While liquidity is generally good, the reality is that we've become addicted to this heightened level of liquidity that HFTs provide. Efficient markets thrived without flash orders in the past, but can they ever learn to do so again?

To those interested, I recommend reading the following explanation as a alternative to the SEC's orthodoxy: http://www.nanex.net/20100506/FlashCrashAnalysis_Intro.html.

Cheers!