The Haphazard Blog

The big news today was the 1000 point drop of the Dow. Early blame is being placed on a bad order for Proctor & Gamble stock. So that makes sense. If a bad order for P&G is executed it’s one of 30 stocks that make up the Dow Jones Industrial Average, so it would send it down a fair amount. But that doesn’t explain all the other stocks dropping.

At 2:45 PM. the DJIA moved from 10,236 to 9,872 (fell 3.6%) )and back to 10,203 (gained 3.4%) in 5 minutes. The NASDAQ, which has over 3,000 components fell 2.6% and gained 2.7% in the same period. The Russell 2000 fell 2.3% and gained 2.7%. Lastly, the S&P 500 fell 1.7% and gained 3.5%.

So it wasn’t just one stock, it was the entire market as a whole that had a very quick drop and a subsequently quick recovery. I believe that the only way that the markets could move that fast and that much is through computerized trading. There was not a massive sell off by humans placing sell (or short) orders.

Instead, the primary culprit was High Frequency Trading and Flash Trading followed by automated trading and the triggering of stop-loss orders. I think it is this last thing that is going to have human investors very upset.

To put it simply, investors will place a stop-loss order to try and limit their losses. What happens is an investor will buy a stock like Apple at $250/share. They will then place a stop-loss order at say $220 to limit their losses to roughly $30/share. The problem here is that computers caused an artificial and drastic move downwards by mostly trading amongst themselves that pushed Apple down below $200. So the investor had their stock sold at $220 as Apple plunged because of this fiasco. Then the market quickly corrected and Apple was back to $246 (and really was under $220 for less than 5 minutes. The investor has lost over $26/share and Apple stock went back to a proper price.

Congress has already been talking about financial reform and tomorrow, and maybe over the next week, they will be pointing to this event as another reason it is so badly needed. This won’t end at a bad trade.