What is a flash crash?
Flash crashes are any fast, sudden drop in market value or stock price; this drop recovers quickly, often in 24 hours or less.
These dramatic drops can happen due to massive stock selling, high-frequency trading, reactions from computer trading programs, algorithms, or a number of other factors that can be hard to identify due to the recovery speed.
Predicting or avoiding flash crashes is difficult, but not impossible. Using a brokerage trading platform helps analyze market transactions and evaluate overall trading risk. Many investors use these platforms on behalf of their clients as part of their services. These platforms determine the likelihood of a flash crash, not whether or not they will definitively happen.
Causes of flash crashes
Figuring out what triggers flash crashes is a tough mystery to solve, especially as technology continues to evolve.
The real answer is that flash crashes can be caused by a number of different individuals, companies, and even computers – anything powerful enough to work quickly at scale. More research is needed to truly understand why flash crashes happen and what exactly causes them, but a few examples of more common, general causes are:
- Black-box trading. Also known as algorithmic trading, this is a way for stock traders to use computers to find effective strategies for buying and selling. This significantly speeds up the trading process in a way that moves too fast for the market to keep pace with.
- High-frequency trading. This cause consists of a collection of things, including short-term investment horizons, trading securities, or any other high speed or high turnover action within the market.
- Computer algorithms. As technology becomes more advanced and the stock market relies on computers and the internet to function, computers have increasingly put the market at risk for flash crashes by overcorrecting in response to trades or price drops.
Ways to prevent flash crashes
Though there is still a lot that remains unpredictable with flash crashes, some measures have been put in place to reduce the chance of one occurring.
Computer algorithms and technologies continue to improve and increase overall security, which makes the overall trading process better in addition to preventing flash crashes.
NASDAQ and other financial institutions and global exchanges have implemented a number of changes in security and trading mechanisms in the last decade to help decrease the risk of flash crashes or to reduce the damage caused if one happens.
Some of these measures include market-wide circuit breakers that can create a pause or complete stop in trading activity if unusual or potentially damaging behavior is detected. Also, exchanges can no longer be accessed via a direct connection.
Flash crash examples
The Dow flash crash in May 2010 was the first. In under 10 minutes, the Dow fell 1,000 points and cost $1 trillion in equity. This flash crash was due to an individual participating in spoofing, which is the process of making stock prices appear to rise and selling those false prices for a profit.
Other examples include:
- 2012: The NASDAQ flash crash. Three hours of trading were lost when the New York Stock Exchange (NYSE) couldn’t understand a NASDAQ server.
- 2013: The second NASDAQ flash crash. A buildup of $500 million in losses occurred when Facebook’s first public stock offering launched.
- 2014: The bond flash crash. This treasury bond note yield dropped from 2.02% to 1.86% in minutes.
- 2015: The NYSE flash crash. For over three hours, all trading within the NYSE stopped and resulted in a loss of 40% of trading volume.
- 2016: The British pound flash crash. The value of sterling dropped more than 6% against the dollar within two minutes; this was likely a result of Brexit fears.
- 2017: The Ethereum flash crash. In just a few seconds, the price of Ethereum dropped from hundreds of dollars to a mere ten cents.
- 2021: The cryptocurrency flash crashes. 2021 was rife with cryptocurrency flash crashes, and this year certainly wasn’t the first year they happened. Early in 2021, Kraken’s prices fell by more than half; in September, many cryptocurrencies experienced a flash crash with an estimated loss of over $400 billion. The price of bitcoin also dropped significantly.
- 2022: The European Stock Market flash crash. Many European stocks dropped abruptly in price, all because of a manual mistake. Citigroup claimed responsibility and fixed the issue within the day.
