Mendoza School of Business

Scholars say high-frequency trading wasn’t to blame for Flash Crash

Published: June 3, 2011 / Author: Ed Cohen

High-frequency traders – presumed by many to be the villains of the 2010 Flash Crash – found some redemption at a recent conference on financial regulation.

One scholar said the algorithm-driven activity actually benefits markets in multiple ways.

An economist for a regulatory agency all but absolved high-frequency traders of blame.

In a paper presented at the Conference on Current Topics in Financial Regulation, June 1-2, 2011, at the University of Notre Dame, Gideon Saar, associate professor of finance at Cornell’s Johnson Graduate School of Management, argues that, among other benefits, high-frequency trading improves liquidity and makes markets less volatile, even during turbulent periods.

The third-annual conference, which brought together 60 academics, regulators and industry professionals, was sponsored by the Center for the Study of Financial Regulation within Notre Dame’s Mendoza College of Business. Presenters and panelists included officials from the SEC and Commodity Futures Trading Commission (CFTC).

The conference opened with a talk by Bill O’Brien (’92), CEO of DirectEdge, an all-electronic stock exchange that accounts for about 10 percent of all trading volume in the United States. In addition to the Flash Crash and high-frequency trading, other topics included credit-rating bias and possible reporting manipulation by hedge funds.

High-frequency trading involves actions carried out on the millisecond scale, about 100 times faster than the eye can blink. High-frequency traders attempt to profit on tiny changes in prices using computers to execute thousands of trades a day on electronic exchanges. This activity now accounts for nearly three-quarters of the trading volume on the NASDAQ exchange, according to one researcher.

High-frequency trading is not just about buying and selling, though. About 90 percent of the activity involves limit orders, the kind that execute a buy or sell order only when a certain price is available. Algorithms written to carry out high-frequency traders’ investment strategies continually place and then cancel limit orders within a few thousandths of a second. Such sequences are believed to act as intelligence-gathering operations, triggering and recording the responses of other algorithms. 

The Flash Crash was the event May 6, 2010, that saw the Dow Jones Industrials average plunge more than 600 points in five minutes, only to regain most of that ground 20 minutes later. At one point, the price of management consulting company Accenture had fallen to 1 cent from $40.13 a share.

Investigations by the SEC and CFTC traced the cause to a large mutual fund firm selling an unusually large number of stock-market-index futures contracts called E-Mini S&Ps. The sale was initiated by a computer responding to a preprogrammed algorithm. That action triggered a cascade of other robotic trading.

Andrei Kirilenko, chief economist for the CFTC, led the commission’s investigation of the Flash Crash. At the Notre Dame conference he presented a paper on the crash and the effects high-frequency trading had on it.

In a survey, retail investment advisers placed the blame for the Flash Crash primarily on an overreliance on computer systems and high-frequency trading. But the analysis by Kirilekno and his co-authors found that high-frequency traders did nothing differently on May 6, so they didn’t trigger the event. It was the mutual fund company dumping such a huge amount of contracts on the market at one time. High-frequency trading did exacerbate the problem, they say, because the practice accounts for so much volume on the exchanges. Other traders saw the high-frequency sale orders as a liquidation trend – a cue to sell – and there were not enough buyers to stabilize prices.

Kirilenko and his co-authors offer no specific policy recommendations on how to avoid another Flash Crash, writing only that “as markets change, appropriate safeguards must be implemented to keep pace with trading practices enabled by advances in technology.”

Founded in 2009, the Center for the Study of Financial Regulation aims to promote sound economic analysis of current and proposed financial regulation. For more information contact Director Paul Schultz at (574) 631-3338 or


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