Federal regulators said Friday an algorithm caused the notorious "flash crash" of May 6 when an automated trading system selling futures contracts on the S&P 500 ($INX) triggered a cascade of selling throughout the broader market.
An already turbulent day of trading reached a tipping point at about 2:30 p.m. Eastern when a "large trader" started selling a total of $1.4 billion in futures contracts "as a hedge to an existing equity position," according to a joint report by the Securities and Exchange Commissions and the Commodities Futures Trading Commission.
Regulators didn't name the trading firm but The Wall Street Journal and other media have identified it as Waddell & Reed.
The trader executed its hedging strategy by using an automated execution algorithm, or "Sell Algorithm," regulators said. "When markets were already under stress, the Sell Algorithm chosen by the large trader . . . executed the sell program extremely rapidly in just 20 minutes," regulators said.
Among other findings, the report concludes that under stressed market conditions, the automated execution of a large sell order can trigger extreme price movements.
Heavy selling of S&P 500 futures contracts was a prime suspect in the immediate aftermath of the Flash Crash, a day in which the Dow Jones Industrial Average ($INDU) swung by more than 1,000 points during the session.
Basics of Diversification
Learn one of the fundamental concepts of building a portfolio.View Course »