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Flash Crash: Rage Against The Machine

Flash Crash: Rage Against The Machine by Worth Wray of Evergreen Gavekal Capital

"The world clings to its old mental picture of the stock market because it’s comforting; because it’s so hard to draw a picture of what has replaced it; and because the few people able to draw it for you have no interest in doing so." - Michael Lewis, author of the bestseller Flash Boys

Summary Of EVA's Key Points

The second widespread US equity “Flash Crash” on August 24, 2015 was a wakeup call for investors.

  • In addition to the S&P 500’s 5% fall as the market opened, blue chip stocks and large “exchange traded funds” (ETFs) suffered enormous 20%+ drops before recovering almost all of their losses in a matter of minutes.
  • As Jeff Dicks explained in our September EVA Chartbook (“Flash Crash 2.0”), this kind of price action is a sign that financial markets have changed in a fundamental way.

The decline of “market making” activity has reduced daily trading volume on major stock exchanges and increased the risk of liquidity shortages in times of panic.

  • Market makers play a critical role in keeping major financial markets liquid and, at times, have been the only parties standing between orderly sell-offs and disorderly crashes.
  • By consistently taking the other side of trades – i.e. selling when the herd bought and buying when the herd sold – they once accounted for a tremendous share of daily trading volume on the New York Stock Exchange, the NASDAQ, and other exchanges.
  • Because these firms either went out of business during the 2008 financial crisis or have been forced to operate at much lower levels of leverage to comply with new regulations, daily trading volume on the NYSE has been cut in half.

Dramatic changes in the mix of market participants has fundamentally changed the way US equity markets behave.

  • As “real money” – including households, institutions, and market makers – has fallen in overall trading since the global financial crisis, “high-frequency traders” (HFTs) and ETFs have grown to account for...