The May 6, 2010 Flash Crash Essay Example | Topics and Well Written Essays - 1250 words

The May 6, 2010 Flash Crash - Essay Example On the contrary, the contemporary market is characterized with higher demand as compared to the supply. Financial innovations enable changes in the financial market by introducing new ways of trading assets. One of the newest financial innovations entails trading from computer to computer through use of complex mathematical algorithms that are hard for humans to comprehend. The recent financial crisis resulted in increased unemployment, which is an indicator of the increased inefficiency of the stock market. This paper agrees with Stiglitz opinion that that Flash Crash will lead to less investment in information, which is harmful to the markets price discovery function hence the financial market. The paper will oppose the opinion that Flash Crash could be a positive feedback loop of the trading environment. Computer trading has become a common phenomenon, which has increased the speed of trading making it impossible for humans to intervene in times of occurrences such as flash crash. Additionally, the explosive trading speed results in undermined efficiency since the market becomes incapable of allocating resources efficiently. Flash Crash entail trading from computer to computer through use of pre-programmed algorithms. ... During the Flash Crash, a contract could be traded for more than 27,000 in a period of about 14 seconds (U.S. Commodity Futures Trading Commission & U.S. Securities & Exchange Commission, 2010; Stiglitz, 2012). According to the SEC report, computer generated algorithms, which are used for high frequency trading comprise more than 70% of trading in U.S. equities. On the SEC joint report on the flash crash of 6 May 2010, the American shares fell by 10% within a few minutes, which resulted in many questions regarding the credibility of nanosecond trading, which characterizes computer to computer trading. The computer based trading does not make use of price discovery but uses algorithms that makes it possible for dealers to extract information regarding expected price of securities through observing patterns of prices and trades. The dealers are thus incapable of making sound decisions. High frequency trading undermines the stability of the market. During the flash clash, high frequency trading firms started by absorbing sell pressure but eventually started forceful selling, which resulted in increased orders in the market and creation of feedback loop. Eventually, the high frequency trading firms began to buy and resell to each other e-mini contracts resulting in decreased net buying irrespective of the increased volume of e-mini contracts. Buyers using traditional trading methodologies refused to buy the extra E-minis resulting in the fall in trading funds. This was because dealers could not comprehend the transactions and feared taking risks. Therefore, computer based trading is inapplicable since there are no clear models on how it operates (Stiglitz, 2012; Mackenzie, 2006). High frequency trading resulted in liquidity crisis when automated trading systems