Flash Crash Analysis
On May 6, 2010, the US Stock Market saw a 1000 point drop followed by a huge recovery in only a few minutes. There were many theories put forward at the time as to what caused the flash crash, but a company called Nanex, a provider of a high-performance, real-time streaming datafeed for all of the major exchanges, did an in depth analysis and their conclusion was that it was caused by a design error at the NYSE.
From Analysis of the "Flash Crash"
In summary, quotes from NYSE began to queue, but because they were time stamped after exiting the queue, the delay was undetectable to systems processing those quotes. On 05/06/2010 the delay was enough to cause the NYSE bid to be just slightly higher than the lowest offer price from competing exchanges, but small enough that is was difficult to detect. This caused sell order flow to route to NYSE -- thus removing any buying power that existed on other exchanges. When these sell orders arrived at NYSE, the actual bid price was lower because new lower quotes were still waiting to exit a queue for dissemination.
This situation led to orders executing against whatever buy orders existed in the NYSE designated market maker (DMM) order book. When an order is executed, the trade is reported to a different system (CTS) than quotes (CQS). Since trade report traffic is much smaller than quote traffic, there is rarely any queueing or delay.
Because many of the stocks involved were high capitalization bellwether stocks and represented a wide range of industries, and because quotes and trades from the NYSE are given higher credibility in many HFT systems, when the results of these trades were published a few milliseconds later, the HFT systems detected the sudden price drop and automatically went short, betting on capturing the developing downward momentum. This caused a short term feed-back loop to develop and panic ensued.
Another interesting tidbit is that they detected what they termed, "Quote Stuffing", were 1000s of quotes per second were being generated for certain stocks from a particular exchange. They surmised that it may have been a form of HFT warfare, where one HFT system generates these quotes so that all of the competing HFT systems will spend precious milliseconds processing them, giving the instigator an edge. They predict that if this behavior is not prevented, soon every HFT system will be using this tactic and pretty much meltdown the whole system. Incredible.
The analysis is at http://www.nanex.net/20100506/FlashCrashAnalysis_Intro.html.