Flash Crash

So the headline statesA Single Sale Worth $4.1 Billion Led to the ‘Flash Crash’”.

It is interesting to see the “cause” of the crash, but how could it ever happen?  Arbitragers had boatloads to benefit by jumping in.. or did they?

After reading a recent article/blog about an individual losing $100k in a month of Forex trading, it became crystal clear to me why the “arbitragers” let events like this occur.  Fortunately the blogger was quite frank.  He lost all his money during “stop-losses” on days he did not pay attention to trading.

While I had always known about “stop-loss”, or subtly read about the literature, I had no idea that so many investors used such a tactic.  As a result, it is pretty darn obvious why professional traders let the crash occur.  They simply ate the lunch of all the casuals with “stop-loss” trades that were left open.

This same phenomena also occurs with “limit orders” that casual investors always argue with me about.  These individual investors always think they are getting a better deal by setting up a limit order.  They are continuely blinded by the fact that market markers do not touch their limit order  arbitrage arises.  I think of it as the reverse stop-loss effect.   It isn’t very difficult for a trader/programmer to figure out who you are, when you have a weird looking limit order that sits there for minutes/hours/days at a time.

So what was the flash crash really?  A simple highway robbery from reckless day-traders.

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