The Flash Crash

The dangers of high-speed computer-generated share trading!

The so-called flash crash that occurred in May 2010 that sent the Dow Jones plummeting nearly 1000 points was the result of high-speed, computer-generated share trading.

The report on the event by US regulators indicated that market conditions were unstable at the time because of growing debt concerns in Europe.

One very large trade caused other high frequency, computer-generated trading platforms to join the fray and this accelerated the sell-off.

The report suggested that when the market conditions are stressed, the automated execution of a large sell trade can cause extreme price movements.

Stock markets around the world are considering what controls may be necessary to limit the volatility that this type of activity may produce.

In the meantime, cases of extreme movements in share prices over short periods may be something that long-term value investors may have to live with.

Nobody has quite worked out what caused the event. However a Financial Times article of December 29 2011 suggests that a "flash crash threatens to return with a vengeance".

Researchers using engineering and scientific skills have concluded that the flash crash was not an isolated event and could be predicted.

This would make them different from black swan events that are considered to be unpredictable, but for which humans concoct explanations for their occurrence after the fact.

To Conclude ...

The possibility of future extreme movements in stock markets over short periods may not be all bad from a value investing perspective.

Value investors need to keep their watch lists up to date in order to take advantage of market falls resulting in flash-crash events.

At these times, highly profitable companies may become available at bargain prices.

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