The Computers Are Sorry About the Flash Crashes

It’s worth spending a minute to talk about what a “flash crash” is. A “flash crash,” conventionally, means that some stock or bond or currency or whatever drops by a large amount very quickly, and then recovers a lot of that amount very quickly. (Colloquially it is also sometimes used to refer to when an asset goes up, and then back down, very quickly, but that’s kind of weird.) Sometimes the thing is worth just as much after the flash crash as it was before, and the flash crash is a pure glitch with no fundamental explanation, but often there is some fundamental shift, and the thing is worth less after the crash than before. It’s just that it’s worth a little less, whereas during the flash crash it was, briefly, trading for a whole lot less. And there is generally no fundamental explanation for that; it’s not like terrible news occurred at 9:30 a.m. and then significantly mitigating news occurred at 9:30:05. The depth and rapidity of the crash is a pure artifact of market structure, not of fundamental value.

So why does it happen? The popular answer is “ooh algorithms ooh” but that doesn’t really tell you much. But here is a very simple model: