Monday, May 10, 2010

Thursday Went Out Swinging

In case your media source is so preoccupied with the Oil Spill that you didn't hear, Thursday, May 6 was a historic day in the stock market.  The Dow recorded its biggest intraday drop ever. At one point, the Dow was down 9.2% from Wednesday's close.  The Nasdaq was down 9.0%.  The S&P 500, 400, and 600 were down 8.6%, 8.3%, and 7.6%, respectively.  All of these indexes recovered quite a bit during the day, still ending down for the day, but significantly higher than their lows.  Look at this Google chart for a visual representation:

We're still trying to figure out exactly what happened.  The market was depressed all week by concerns about Greece and the Euro, so it wasn't surprising the market was heading down on Thursday.  Something happened around 2:30pm, though.  There was speculation that a trader accidentally entered a trade for a billion instead of the intended million; this has not been confirmed.  It could be that the initial problem was related to Proctor & Gamble or 3M, who together made up a huge chunk of the Dow's drop.

Whatever started the drop, the continuation was likely caused by quantitative, computer executed portfolios.  Some asset managers run portfolios by creating models that are then executed automatically by a computer.  They might have rules in place that say something like "if P&G goes down more than 3% in 10 minutes, then sell a third of our holdings."  This sort of trade would push the price of P&G even lower.

Clearly, other asset managers, either manually or via other quantitative models (probably both), jumped on the sudden drop and started buying.  This brought the market back up close to its earlier levels.  Also, some of the trades that happened during this 20 minute window are being canceled.

The markets continued to suffer on Friday, and the volatility of the S&P 500 hit its highest in over a year.  At the time of this posting on Monday, May 10, though, the markets are up between 3.8% and 4.5%, and volatility is down over 34%.

2 comments:

  1. Is it likely that we'll ever find out what caused the initial drop? And, is that information even useful? I'm glad to hear that things are a bit better today.

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  2. We should be able to figure out what happened. All the trades are recorded with the exchanges, and the SEC could interview the people involved in those trades to determine why those trades were placed.

    We can use that information to build better safe-guards into the trading system to keep a similar event from happening again. It could also help the quantitative portfolio managers build better models.

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