A flash crash is understood as a sudden extreme market movement with no obvious cause and often connected with automated trading systems. Markets have been subject to crashes throughout history, but the flash crash is a more recent phenomenon closely associated with derivatives and computerized algorithmic trading.
The first of the computer-era flash crashes was the Oct. 19, 1987, stock market crash that took major indexes down over 22% in one trading day (equivalent to a loss of about 5,400 Dow points in one day using today’s levels). That 1987 flash crash involved a complex interplay between Chicago futures markets and the U.S. stock exchanges based in New York.
Other famous flash crashes include the Oct. 15, 2014, flash crash in Treasury yields, the May 6, 2010, flash crash in the Dow Jones index (a 9% crash in less than 30 minutes) and the January 2015 crash of the euro against Swiss francs (down 25% in 30 minutes). There are many other examples.
The latest flash crash, a $41 billion loss in the market value of Jardine Matheson in a matter of minutes, is described in this article. What all of the flash crashes have in common is computerized trading and a piggyback effect where an initial price movement is copied by other automated traders to produce a cascade that soon spins out of control.
In most (not all) cases, the overshoot is recognized and markets correct, sometimes the same day. What happens if the flash crash losses are not truncated? What happens when the flash crash spreads to other instruments or other markets and a full-scale one-way panic emerges?
The ability of central banks to mitigate a flash crash today is greatly limited compared with 2008 because the central banks have not normalized their balance sheets since then. Investors need to prepare with diversification across asset classes and larger-than-normal cash reserves to withstand the damage.
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