Mini flash crashes worry traders

Mini flash crashes still occur routinely with individual stocks, a sign some of the problems that contributed to the short-circuiting of the markets more than a year ago are still happening.

Despite efforts to prevent another flash crash, the infamous day on May 6, 2010, when the Dow Jones industrials fell roughly 900 points, only to quickly recover, regulators and markets have moved to implement safeguards.

Yet, traders and market observers are still seeing individual stocks and ETFs suffer flash-crash-like events, when stocks fall suddenly for no reason and quickly rebound, suggesting many of the underlying problems haven't been solved.

"Nothing has changed," says Eric Hunsader of Nanex, a firm that collects market and trading data. "The complacency has made it worse."

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Collecting precise data on these mini flash crashes is difficult, as they often occur in the blink of an eye due to rapid-fire electronic trading. Finding them requires processing billions of trades. Some of the trades, but not all, are ultimately canceled.

Neither Nasdaq nor the New York Stock Exchange discloses statistics on when trades are canceled for being erroneous. And the amount of data that must be crunched is so immense that there is a several-month delay for outside observers to tally the total number of bad trades.

VIDEO: A government report in October 2010 determined the so-called "flash crash" was caused by a single trading firm executing a computerized selling program in an already stressed market.

The most recent data available are for the first month and three days of 2011. In that period, stocks showed perplexing moves in 139 cases, rising or falling about 1% or more in less than a second, only to recover, says Nanex. There were 1,818 such occurrences in 2010 and 2,715 in 2009, Nanex says.

Recent dramatic examples:

•Jazz Pharmaceuticals' stock opened at $33.59 on April 27, fell to $23.50 for an instant, then recovered to close at $32.93. "There was no circuit break," says Joe Saluzzi, trader at Themis Trading, because Jazz did not qualify for rules the exchanges put in place after the flash crash for select stocks following extreme moves.

•RLJ Lodging Trust was an initial public offering on May 11. It opened at $17.25 its first day, then a number of trades at $0.0001 took place in less than a second before the stock recovered. The trades were later canceled, but it's an example of exactly what is not supposed to happen anymore, Hunsader says.

•Enstar, an insurer, fell from roughly $100 a share to $0 a share, then back to $100 in just a few seconds on May 13.

•Ten exchange traded funds offered by FocusShares short-circuited on March 31. One, the Focus Morningstar Health Care Index, opened at $25.32, fell to 6 cents, then recovered, says Richard Keary of Global ETF Advisors. The trades were canceled. "No one knows how frequently this is happening," he says.

•Health care firms Pfizer and Abbott Labs experienced the opposite of a flash crash on May 2 in after-hours trading. Abbott shares jumped from $50 to more than $250, and Pfizer shot from $27.60 to $88.71, both in less than a second, Nanex says. The trades were canceled.

The exchanges have attempted to remedy these situations by halting some stocks if they fall 10% or more in a short period.

But some stocks aren't covered, and there are exceptions to the circuit breakers that even confuse many traders, Saluzzi says.

Also, erroneous trades can only be reported in the first hour after they happen, so if they aren't caught quickly, investors can lose out, Saluzzi says.

Many of the inexplicable moves by stocks were due to erroneous orders that originated outside the NYSE, says the NYSE's Joe Mecane. Errors have always been part of financial markets, yet after the flash crash, there's more attention being paid to errors and more sensitivity toward them, he says.

Such extreme volatility is the tradeoff for fast electronic markets, and it's up to investors to know how to protect themselves, says Larry Harris, professor of finance at the University of Southern California.

Yet, more changes need to be made, says James Angel, professor at Georgetown University: "We've made good progress, but we need to put better (safeguards) in place for all stocks."