Flash crash – What they are and how to prevent them.

A flash crash is an unexpected and aggressive decline in the price of an asset. The characteristics of this event are randomness or human error, where the prices of a certain asset collapse quickly and aggressively, something that causes collateral damage to investment funds and large companies. Let's see what flash crashes are, how to prevent them and which are the most important in history.

What is a flash crash?

A flash crash is a unexpected and aggressive decline in the price of an asset. This term is used to describe rapid declines in asset prices, whether stock stocks, indices, commodities, currencies or cryptocurrencies. These declines in asset prices are usually unexpected, so Protecting yourself from this is somewhat difficult.. Within the cryptocurrency market is where the most notorious flash crashes have been witnessed, having witnessed abysmal falls of up to 50% on different occasions, such as in the recent collapse of FTX or Terra or during the start of the pandemic in 2020.

How a flash crash occurs.

A flash crash in general can happen for two reasons; both for a technological error as well as human error. Technological errors can happen due to failures in software systems that connect market data with stock market data, which can end up causing a imbalance in the application of prices inaccurate in a specific asset. At the same time, the human factor also influences, given that human errors can happen for different reasons:

• Human beings can make mistakes such as add an extra zero to an order or make a operation of large magnitudes at an incorrect price. This may cause a flash crash to occur.
• There are certain illegal practices that are considered market manipulation by humans, which consist of send buy/sell orders in bulk to try to confuse the artificial intelligence bots of large funds, consequently causing an imbalance between the volume of buy/sell orders and consequently, expanding the magnitude of the falls.

How to prevent a flash crash.

Certainly There is no effective way to prevent a flash crash., given that they are events that we could incorporate into the category of black swans, which are not events that can be prevented, such as, for example, catalytic events o macroeconomic indicators such as the publication of employment data, construction permits or announcements of increases or decreases in interest rates by central banks. But as always, everything also has its protection; Using a Stop Loss Order It can save us from unexpected headaches such as flash crashes.

Most famous flash crash in history.

Throughout the history of stock markets, multiple flash crashes have occurred that have marked the stock markets and pockets of large global investment firms. Certainly there are different flash crashes that are more noticeable than others, of which we can highlight:

Dow Jones flash crash in 2010.

On May 6, 2010, the most notorious flash crash in the history of Wall Street occurred. In just 5 minutes the Dow Jones Industrial Average index plummeted 1.000 points (equivalent to 9%) due to fears of the Greek debt crisis. The index opened with a loss of 300 points, which increased until it fell abruptly by up to 1.000 points in less than 5 minutes. At the same speed as it fell, it recovered half of the fall, but the collateral damage to large funds and investors had already been done.

Later, in 2015, it was discovered that there was a person behind all this flash crash; Navinder Singh Sarao. This trader who had his own company called Nav Sarao Futures Limited, achieved through placing bulk sell orders knock down the Wall Street market. He was tried by the Commodity Futures Trading Commission and forced to pay a fine of 50.000 pounds, something that compared to the more than 40 million that he managed to get with his play is quite negligible.

Flash crash sterling 2016.

The 7 of October of 2016 the pound sterling lost up to 10% of its value in just a few minutes of trading, fueled by concerns about the vulnerability of the currency and other UK assets to Brexit. Although the pound sterling is usually a strong currency, this is not the first time we have seen it lose a large part of its value quickly. At the end of September 2022 also suffered a large depreciation which brought it almost to parity with the US dollar after the announcement of some disastrous measures proposed by Liz Truss that were going to seriously harm the English economy.

Flash crash Bitcoin in March 2020.

As we mentioned at the beginning, the cryptocurrency ecosystem stands out above all for the high volatility usually present in its market, which has caused the reference asset, Bitcoin, to be affected by flash crashes on different occasions. One of the most notable was on March 12, 2020, when the WHO declared Covid a pandemic, which scared investors in all markets and began a massive sell-off that dragged Bitcoin into hell. In just one day we witnessed a big drop of 39%, losing close to 52% of its value in less than 24 hours.

Flash crash European stock markets 2022.

This flash crash was one of the most recent that we have experienced in recent years. It all started when the main Swedish stock market index plummeted about 8% suddenly, something that quickly spread to the vast majority of European indices, including the Stoxx 600. It was later discovered that It was a human error caused by investors of the Citigroup firm, which incorrectly issued a sell order that caused a collapse in the European indices. Luckily, they were able to recover quickly, but the damage was already done.