
Understanding ETF “Flash Crashes” - jonbaer
http://www.factset.com/insight/2015/08/understanding-etf-flash-crashes#.VeRJ69NVhBc
======
phkahler
This whole thing was triggered at opening. Why does the market even close
these days? There is "after hours" trading going on for some people. Why
shouldn't the computers be running 24/7? Is there some batch stuff that goes
on after close? I've seen cases where transactions were unwound, but aren't we
nearing real-time across the board?

~~~
jperras
Wouldn't you like to sleep, at some point?

~~~
aianus
Banks can (and already do) have multiple shifts.

I used to work for a forex broker (forex is 24h a day) and we had offices in
different timezones (Toronto, New York, London, Singapore) so we would always
have trader coverage without requiring night shifts.

~~~
branchless
And you had full 3rd level knowledge of all issues in all regions? Or key
people in key regions who got woke up a lot? They should run these things for
an hour a day 4 days a week. It's just a game, we don't need this.

~~~
aianus
You don't have to participate. But I don't see how it's your business if
people want to trade equities 24h a day any more than if people want to open a
24h McDonald's.

~~~
toomuchtodo
Adding more trading hours to the day doesn't serve a productive purpose.

~~~
monochromatic
"I don't see a reason for this, so you shouldn't be allowed to do it."

Not very good reasoning. It's not exactly on point, but I'm reminded of a
quotation from G. K. Chesterton:

> In the matter of reforming things, as distinct from deforming them, there is
> one plain and simple principle; a principle which will probably be called a
> paradox. There exists in such a case a certain institution or law; let us
> say, for the sake of simplicity, a fence or gate erected across a road. The
> more modern type of reformer goes gaily up to it and says, “I don’t see the
> use of this; let us clear it away.” To which the more intelligent type of
> reformer will do well to answer: “If you don’t see the use of it, I
> certainly won’t let you clear it away. Go away and think. Then, when you can
> come back and tell me that you do see the use of it, I may allow you to
> destroy it.”

~~~
toomuchtodo
I'm not saying you shouldn't be allowed to, I'm saying that even if it was
permitted, it wouldn't be productive.

I mean, this is Hacker News. We discuss all day about what should or shouldn't
be done. If you want action, go out and do it. Otherwise, we're just
armchairing all of this.

------
vasilipupkin
"When irrational actors are at work (and let’s be clear, anyone selling RSP
for half off isn’t being rational), the smartest thing to do, if you’re the
actual human being watching RSP trade, is to simply step out for a cup of
coffee". If you honestly believe that selling for 50% off is irrational, then
you should not step out for coffee but put in bids and buy that ETF. That's
the rational thing to do, conditional on your beliefs about valuation.

~~~
eogjnjoeg
No, that's irrational.

Stock opens at X, you buy at 0.5X, you sell at 0.9X, it goes back to X. Then
the exchange breaks the 0.5x trade. Now you still have to deliver the order
you sold at 0.9x, but you're buying it at X, so you've earned a neat loss.

The rational thing to do is to get a cup of coffee. Unless you enjoy losing
tons of money, in which case your idea is great as well.

~~~
PhantomGremlin
_Then the exchange breaks the 0.5x trade_

Yeah, this can't be overemphasized. When some widow or orphan (or more likely
GS) is on the other side of the trade, then clearly it should be broken.
Wouldn't want them to lose any money. /sarcasm

As you say, the rational action is not to play.

Other people have opined on this and said that, if the "clearly erroneous"
rules are properly defined, then a trade should _never_ _never_ _never_ be
broken. It should simply not be allowed to go thru. That makes more sense to
me.

Edit: And for those who think this is merely hypothetical, or just whinging,
you should read this:
[http://www.ft.com/cms/s/0/37fff9c6-0b36-11e3-bffc-00144feabd...](http://www.ft.com/cms/s/0/37fff9c6-0b36-11e3-bffc-00144feabdc0.html)
GS trades were broken. Hopefully the FT paywall won't block that link, it
worked for me when I searched for the story. So who knows.

~~~
lotharbot
> _" the rational action is not to play"_

The rational action is not to attempt a _short-term_ play. Having one side of
your two-sided trade broken is a very bad outcome.

But if you're making a long-term play, that consideration is irrelevant.
There's no "other side" of the trade for you to match up with. If you get an
asset at 0.5X and then _don 't sell it_ and then the exchange breaks the
trade, you get your money back and you're no worse off than when you started.
But if you happen to grab an asset at 0.5X and the exchange doesn't break the
trade, then you gained an asset for half of what it's worth. Now you've got a
great asset in your portfolio, only you have twice as much as you should have
been able to afford. That's a _great_ move!

------
stygiansonic
For a related article concerning this sort of market microstructure and the
behavior of its participants, see this post by Matt Levine:
[http://www.bloombergview.com/articles/2014-12-01/apple-
had-a...](http://www.bloombergview.com/articles/2014-12-01/apple-had-a-rough-
morning)

I especially liked this quote: _" The equity market is set up to dampen small
movements (market makers tend to buy when others are selling), to exacerbate
mid-size movements (as market makers capitulate and stops get triggered), and
to dampen large movements (as circuit breakers cut off trading and let
algorithms catch their breath)."_

From my layman's point of view, it seems like this sort of "system behavior"
is a peculiar emergent property that derives from the rules of the system and
the individual actions of the actors working under those rules.

~~~
mrchicity
Definitely. That's the world of market microstructure. You could certainly
change the rules but there might be other unintended consequences. For
example, removing circuit breakers could make people less confident in the
market since a fat finger order or error could mean Game Over instead of a
manageable but significant loss.

------
roymurdock
Equity markets have become so complex and convoluted. It seems like a silly
game of people trying to fool each other through layers of abstraction:

How can we take the fundamentally abstract idea of a company, its products,
its business model, and its future potential, abstract that one level to a
claim for some "portion of the company" (one share of equity, or a stock),
abstract that into an index that tracks a portfolio of companies based on some
abstracted notion of how to weigh different companies to model some desired
strategy that tracks a market, sector, or industry. Then we're going to build
software in order to abstract the task of trading whatever residual is
leftover from this process amongst ourselves using formulas and algorithms
that we think will outperform or trick other formulas and algorithms.

It's fascinatingly complex, which is why I suspect so many people on HN are
trying to figure out how things like an ETF flash crash could happen. But for
the average retail investor, it's damn-near impossible to comprehend.

~~~
harryh
The average retail investor doesn't need to comprehend it.

~~~
roymurdock
Agreed. But if retail investors are allowed to plow money into the stock
market, then regulators need to understand it. Which I'm not sure is the
case/is entirely possible with the complexity of modern finance.

The average consumer doesn't need to know anything about the drugs she takes.
She just needs to know that the drugs are FDA approved and that she can trust
the FDA.

I guess it comes down to how much you trust the SEC, FINRA, NYSE, etc. to
stabilize and support markets. I have no idea if they're doing a good job or
not. Any thoughts?

~~~
__d
There are opinions on both sides. Some are quite insistent that the SEC etc
are not doing enough: eg. Themis, Nanex, most of the ZeroHedge crowd. I think
the "SEC is doing fine" crowd is less noisy, but probably the majority.

Of course, opinions can be influenced by whether the management of the markets
is to your financial benefit, and perhaps that's why there seem to be a more
people saying nothing: they're heads down, quietly making a fortune ...

It's worth noting (again) that the LULD circuit breakers were introduced after
the 2010 flash crash, as an attempt by the regulators to "stabilize and
support" markets. In some previous events, I think they've worked better than
they did on Monday.

------
drcode
So, the take-home for me seems to be that there are weird regulations on these
types of ETFs that block liquidity (like the "current single stock circuit
breaker rule") and when you take that and combine that with preset orders
(mainly stop loss orders) you have all you need to create a textbook chaotic
system.

~~~
dnadig
The single stock circuit breakers were put into effect after the 2010 "flash
crash" and they're designed to "let cooler heads prevail" when stocks or ETFs
go wonky. The problem is that in a real panicky freefall, it just makes the
window where the stock is trading very very small (it halts for 5 minutes,
opens, hits the next breaker, halts for another 5 minutes, etc.)

It happens both up AND down. This last monday was really the first time they'd
been tested en mass.

~~~
aianus
Who cares if stocks flash crash? If you're buying stock for short term profit
you deserve to be screwed by volatility and I have no sympathy for you.

~~~
josu
>If you're buying stock for short term profit you deserve to be screwed by
volatility and I have no sympathy for you

These people increase market liquidity, they too serve a purpose. If only long
term investors were in the market, the exchanges would end up looking like
ebay.

~~~
netrus
Why would that be a bad thing? (honest question)

~~~
mrchicity
Because most people have things they'd rather do than playing trader when
their expertise is in something else. Being able to trade in and out of assets
at a fair price at any time is valuable. Would you rather have your net worth
tied up in a liquid index ETF or illiquid startup equity?

~~~
toomuchtodo
If I need the cash more than a few years out, whichever provides the highest
return, like all long term investments.

------
VLM
The linked article interpretation is really good as a long format, but as a
very short format in EE-ish math-ish terms HN readers will likely understand,
market prices are not fractal and are occasionally very noisy on small scale.

They aren't fractal in that they are strongly scale sensitive, and at a small
scale over a short enough time period on an unusual day you're basically
looking at noise.

As per innumerable statistical analysis given enough noise samples all
possible values (of price) are eventually, however temporarily, touched.

"Lastly, if we’re concerned about protecting individual investors, we need
better education and controls around the most dangerous tool in the ETF
investor’s toolbox: the market order."

Seriously, those things should just be banned from retail investment and
retail investment education.

~~~
gnaritas
> Seriously, those things should just be banned from retail investment and
> retail investment education.

What? That's absurd, you want to ban "buy/sell now" at the market price? There
is no justification for wanting to ban the most basic and most ordinary
transaction type.

~~~
bcoates
That's not what a market order does. It buy/sells at an unknowable future
price.

~~~
gnaritas
I trade, I know exactly what a market order is.

It buys at the current market price, which during the filling of the oder may
slip as liquidity slips; that's the entire point, fill this order now no
matter what. To not have such an order means having your entries and exits
fail or partially fill which means you'll just have to reinvent the market
order yourself to continue pushing through your order. To ban a market order
is to tell me I'm not allowed to enter/exit a position in a single order,
that's non-sense. If you don't want slippage, don't use a market order but
that comes with the side effect of failed/partially filled orders.

~~~
gd1
>To ban a market order is to tell me I'm not allowed to enter/exit a position
in a single order, that's non-sense.

You could carry on trading as you currently are. If a stock is trading
$100/$100.1 and you want to buy it ('now' as you say), then just set your
limit to $1000.

Of course, you will have no one to blame but yourself if, during the ~50
milliseconds it takes for the order to reach the exchange, the market makers
have switched off and you end up crossing a massive spread and buying the only
available offer at $600 or something. An incredibly unlikely scenario, but it
can happen.

So I imagine you'll set your limit to something sensible, like $101. It'll
still get filled 'now' 99.9999% of the time. But you won't be taking the risk
of doing something epically stupid. There, that wasn't so hard now was it?

~~~
gnaritas
> So I imagine you'll set your limit to something sensible, like $101. It'll
> still get filled 'now' 99.9999% of the time. But you won't be taking the
> risk of doing something epically stupid.

Your scenario doesn't handle the case a market order does, i.e. close my
position now. In a fast moving market, using limit orders for stops or exits
is just going to result in partial fills or failed orders. If I want out, I
want out, I don't only want out if I lose between X and Y, I want out period;
that's what market orders are for, for that convenience, you accept slippage
as a reality.

> There, that wasn't so hard now was it?

No, it's easy to do things that don't work, I can pump my order into
/dev/null, that's easy too, and it's just as useful as a limit order for
stops.

~~~
gd1
>Your scenario doesn't handle the case a market order does, i.e. close my
position now.

I covered that. If you really, truly, want to sell at _any_ price(and I can't
imagine why, that is terrible trading), then you set your limit to zero.

That's all a market order is - a special case of a marketable limit order
(immediate or cancel/fill and kill/etc) with the limit set to zero (in the
case of a sell) or infinity (in the case of buy).

Banning vanilla market orders just forces people to acknowledge that fact,
which is a good thing.

~~~
gnaritas
> I covered that. If you really, truly, want to sell at any price(and I can't
> imagine why, that is terrible trading), then you set your limit to zero.

Perhaps to avoid a margin call; your imagination is limited, you seem to
forget you also have to buy/sell to exit a position when holding on is not an
option. Terrible trading is holding on until you get margin called; when your
risk management says get out, you get out. A stop loss isn't a stop loss if it
can fail to fill or only get partially filled, a market order is exactly what
one desires in a stop loss.

> That's all a market order is - a special case of a marketable limit order
> (immediate or cancel/fill and kill/etc) with the limit set to zero (in the
> case of a sell) or infinity (in the case of buy).

Yes, and thus no need to ban it.

> Banning vanilla market orders just forces people to acknowledge that fact,
> which is a good thing.

You can't force people to acknowledge details they don't care to know about.
Ban this, ban that; it's all non-sense from people who think they can force
the ignorant to learn, you can't. Banning market orders achieves nothing.

------
testerralph
> Sleeping-stops kill...If you had a stop to sell if RSP crossed under $70,
> say, right after the open, your order became a market order, and you could
> have been executed anywhere in the line of terrible trades.

Is there another mechanism that serves the same purpose as a market order, but
that isn't quite so vulnerable to these flash panics? Maybe something like
"sell if it stays below $X for more than an hour"? Though I guess that
wouldn't save you if the crash really was because of bad news.

~~~
seanhunter
I used to work on the algo-trading desk of a big brokerage firm (so writing
trading algorithms that execute other people's orders for them), and I have to
say almost always if someone sends a market order, it would be safer for them
if they sent the same thing as an aggressive IOC ("Immediate or Cancel") limit
order. The IOC flag gives similar semantics to a market order (in that no
portion of your order is going to stay on the book if it's unfilled), but you
are guaranteed to execute no worse than the limit you have set. This is
clearly way better in situations where the market has big dislocations.

~~~
yummyfajitas
The problem with the IOC order is that you have execution risk. I.e. quite
possibly your order isn't filled. Then if your favorite stock were to go down
and _stay down_ , you would still be holding it.

In short there is no perfect "stop loss" order. There is either price risk or
execution risk - pick your poison.

That said, unlimited price risk and zero execution risk is probably NOT the
optimal point to be at.

~~~
secabeen
I'm not sure about that. If the market is moving in an orderly fashion, and
you're trading in a very liquid asset, market orders remove a psychological
impediment to trading. For someone who trades 3-5 times a year, doing a limit
order requires additional consideration (making sure you're doing the right
limit, setting a limit price, etc.) If you just want to buy or sell some stock
for reasons totally unrelated to trading, It's rational to accept a tiny risk
that the market is going to have a shit fit between when you hit submit and
when your order is filled 2 seconds later when the news is quiet.

Certainly, I would never put in a market order when the market is operating
under circuit-breakers and things are unstable. When things are stable, it can
be a reasonable choice for someone transacting in stock who just wants it done
so they can get on with other things they have to do.

~~~
kasey_junk
If you are trading 3-5 times a year, I'd argue that requiring people to put in
the limits on their limit orders would be a good thing.

It makes people think about how the market _actually_ works instead of how
they hope it works.

~~~
secabeen
But what benefit does that actually have? People aren't going to remember this
interaction or learn anything, they're just to be annoyed at having to come up
with that number. They might even put off the transaction.

I would be in favor of restricting the use of market orders by non-
professionals during any time a market special rule is in place (circuit
breakers, Rule 48, etc.) However, I think allowing them during normal market
operation makes transacting easier for investors, which is also a good thing.

~~~
kasey_junk
If someone is so annoyed to have to come up with a price that makes their
order invalid, I'd argue they _should_ put off the transaction.

------
wusatiuk
What i don´t understand is - there are arbitrage players, who calculate "real
value" of the single stocks in each ETF. Aren´t they liquid enough? Because if
they were, the price would not drop that much, would it?

~~~
lmm
A lot of stocks were hitting circuit breakers IIRC, so some of the underlying
single stocks simply weren't trading for part of the time.

~~~
wusatiuk
ahh, so arbitrage players simply paused trading, as their automated
calculations where incomplete?

~~~
lmm
Yeah. A human can probably spot the difference between a flash crash and a
true crash, at least after making a few phone calls - but by that point the
opportunity has probably gone.

~~~
minimax
I know it's anecdotal, but I have heard from some of my human prop trader
friends about guys who made a killing buying on Monday morning.

------
hiou
Are we sure causing those halts was unintentional?

~~~
kasey_junk
Are you suggesting a market actor was manipulating the market so that no one
could trade? Can you come up with a scenario where someone could make money
doing that?

~~~
btbuildem
One scenario would be to gum up the market during a volatile time - eg to
retain "value" while investors are panicking.

But I would lean towards the halts being an unintentional (as in: not well
thought through) consequences of all the layers of regulation and counter-
regulation.

------
inglor
Pfft. [https://www.tipranks.com/etf/rsp](https://www.tipranks.com/etf/rsp)

