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Fallout of the Flash Crash - One Year On

While the nation's top securities regulator contends there's no foolproof way to prevent a repeat of last year's "Flash Crash," experts argue the chances of a sequel are remote thanks to the safeguards put in place in its aftermath.

While the nation's top securities regulator contends there's no foolproof way to prevent a repeat of last year's "Flash Crash," experts argue the chances of a sequel are remote thanks to the safeguards put in place in its aftermath.

To stop a flash crash in its tracks, the Securities and Exchange Commission (SEC) implemented circuit breakers to curb volatility and stop wild price swings; prohibited the practice of offering to buy or sell stocks at prices not in line with the market; and established rules banning "naked access" to the market.

Nevertheless, the terrifying plunge that took place on May 6, 2010 -- in which U.S. stocks lost nearly $1 trillion in value in a matter of minutes before recovering -- continues to linger in the back of investor's minds, particularly on the retail side.

Combined with the largely poor view the general public holds of high frequency trading and the fragmented marketplace, the U.S. equity markets are fighting a losing public relations battle; one that's at least partially reflected in trading volumes that are sharply beneath where they were prior to the crash.

And while the events of May 6, 2010 aren't the sole reason for investors pulling away from the U.S. equity markets, experts say they are definitely part of the problem.

"I'm not sure they're leery about another flash event, they're just concerned about the markets and it's one of a number of things that has soured folks to equities," says Larry Tabb, the chief executive of research and advisory firm Tabb Group.

"On the retail side they're more leery about market structure and whether the equity markets are rigged. For the last two or three years more legislators and commentators have been saying the equity markets are rigged and you're at a complete disadvantage in the market, which is completely untrue," he says.

Tabb says this perception shares some of the blame for why investors are on the hunt for options beyond equities. In the month preceding the flash crash, the New York Stock Exchange averaged nearly 1.2 billion shares traded. But by March 2011, that figure had fallen to 897.8 million shares a day, according to data compiled by Tabb Group.

"Between internalizers -- the interdealers who pay brokerage firms for their order flow -- and traditional crossing networks, that's a lot of a volume. That's a lot of volume to come off the exchange where you lose some price discovery," says Joe Saluzzi, co-head of equity trading at Themis Trading. Saluzzi agrees with the notion the flash crash has caused more retail investors to see the market as being rigged.

"When it comes to institutional investors, even though they know the systems, there are still issues out there. Every day there's a flash crash, a stock moves for no reason," he says.

Earlier this week, more than 50 companies -- primarily in the healthcare industry -- were tagged with bad trades that had to be cancelled later. There have also been a number of lower profile crashes over the last year.

In March, 10 exchange traded funds on the New York Stock Exchange and Nasdaq OMX were nearly wiped out, with some losing nearly 98 percent of their value before circuit breakers kicked in. The exchanges eventually cancelled the errant trades.

Shares of stock market favorite Apple Inc. even endured a mini flash crash in February when its value dropped 2 percent for no apparent reason in a matter of minutes before recovering. And on Wednesday of this week, a single trade of the stock had to be cancelled by BATS Exchange after being priced well beneath its day-earlier closing price.

John Bates, the founder and chief technology officer of Progress Software disputes the notion that investors aren't confident in the market, but says these incidents show how vulnerable the exchanges continue to be a year later. "You are seeing more and more mini flash crashes, and you've seen algorithms go wrong, and rogue traders," Bates says. "It's like earthquakes. You get mini-tremors and then you get a big one."

As the Senior Editor of Advanced Trading, Justin Grant plays a key role in steering the magazine's coverage of the latest issues affecting the buy-side trading community. Since joining Advanced Trading in 2010, Grant's news analysis has touched on everything from the latest ... View Full Bio

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