May 6, 2010 stock market decline/plunge: Why did it drop 9% in a few minutes?
"No one is quite sure what happened (yet).  Speculation includes: The interesting thing is that Procter & Gamble stock got hammered, as did Accenture.  Both of which are fairly stable companies, that didn't make any major announcements, and aren't really connected to the current financial instability in Greece.  So, there is no reason for there stock prices to have gone crazy like that.  This points to some kind of screw up, and not a regular market force. Apparently, the trades involved in this event are going to be canceled. Edit #1: One thing that can contribute to an event like this is automatic selling triggered by stop loss orders.  Say someone at Citi makes a mistake and sells too much of a stock.  That drives the stock price below a certain threshold.  Computers that were pre-programmed to sell at that point start doing their job.  Now the price goes even lower.  More stop-loss orders get triggered.  Things start to snowball.  Since it's all done by computer these days something like this can happen in seconds.  All the humans are left scratching their heads. (No idea if that's what actually happened.) Edit #2: IEEE Spectrum has a pretty concise article on the topic.  It also includes some links to follow. Edit #3 (05/14/2010): Reuters is now reporting that a trader at Waddell & Reed triggered all of this, but not through any wrongdoing. Edit #4 (05/18/2010): Waddell & Reed claims they didn't do it.  The House Financial Services Subcommittee investigated, but they couldn't find a ""smoking gun"".  I think at this point, people have pretty much given up trying to figure out what happened. Edit #5 (07/14/2010): The SEC still has no idea.  I'm giving up. :-)" I hate attributing an event like this to a single cause.  That implies that the market is an orderly system where everything operates smoothly.  I prefer to see it as much chaotic. When I see a drop like that happen, I'd say that there were a lot of sellers of stocks and all the buyers were bidding less and less for those few minutes.  Perhaps the catalyst for that was a typo or a strange order.  But in the end all the participants in the market responded by bidding down stocks, not just one person.  It takes sides to complete a trade. I know my model is a bit simplistic...  I'd be happy if someone corrected me :-) Trading error at Citi "Part of it was an Oops, but not all of it. There were reports that the sudden   drop was caused by a trader who   mistyped an order to sell a large   block of stock. The drop in that   stock's price was enough to trigger   ""sell"" orders across the market. Source: http://www.msnbc.msn.com/id/36983596/ns/business-stocks_and_economy/"
"China's chief central banker warned markets are fully valued and therefore susceptible to a drastic price correction -  triggered by a wide-spread, simultaneous reversal of opinion in the markets. Basically the point when the ""Greater Fool"" phenomenon ends and and selling pressure spikes as everyone starts getting out because they think everyone is. Simplified af but thats the laymen interpration of a minsky moment." "Learn something new every day... I found this interesting and thought I'd throw my 2c in. Good description (I hope) from Short Selling: What is Short Selling First, let's describe what short selling means when you purchase shares of stock. In purchasing stocks, you buy a piece of ownership in the company. You buy/sell stock to gain/sell ownership of a company. When an investor goes long on an investment, it means that he or she has bought a stock believing its price will rise in the future. Conversely, when an investor goes short, he or she is anticipating a decrease in share price. Short selling is the selling of a stock that the seller doesn't own. More specifically, a short sale is the sale of a security that isn't owned by the seller, but that is promised to be delivered.  Still with us? Here's the skinny: when you short sell a stock, your broker will lend it to you. The stock will come from the brokerage's own inventory, from another one of the firm's customers, or from another brokerage firm. The shares are sold and the proceeds are credited to your account. Sooner or later, you must ""close"" the short by buying back the same number of shares (called covering) and returning them to your broker. If the price drops, you can buy back the stock at the lower price and make a profit on the difference. If the price of the stock rises, you have to buy it back at the higher price, and you lose money. So what happened? The Plan The Reality Lesson I never understood what ""Shorting a stock"" meant until today. Seems a bit risky for my blood, but I would assume this is an extreme example of what can go wrong. This guy literally chose the wrong time to short a stock that was, in all visible aspects, on the decline.  How often does a Large Company or Individual buy stock on the decline... and send that stock soaring? How often does a stock go up 100% in 24 hours? 600%?  Another example is recently when Oprah bought 10% of Weight Watchers and caused the stock to soar %105 in 24 hours. You would have rued the day you shorted that stock - on that particular day - if you believed enough to ""gamble"" on it going down in price." Ultimately no one really knows what causes the markets to rise and fall beyond supply and demand. If more people want to buy then sell, prices go up. And if more people want to sell, prices go down. The news channels will often try to attribute a specific reason to the price move, but that is largely just guess work to fill up the news pages so people have something to read. You may find it interesting to read up on the Elliot wave principle. The crash of 2008 was a perfect Elliot Wave fit. Elliot Wave theory states that social moods (which ultimately drive the stock market) generally occur in a relatively predictable pattern. The crash in September was a Wave 3 down. This is where the majority of people give up hope. However there are still a few people who are still holding on. The markets tend to meander about during wave 4. Finally the last few people give up hope and sell out. This causes the final crash of wave 5. Only when the last person has given up hope can the markets start to go up again.. Everyone and their grandmother has been expecting QE to taper since May 2013. If the drop is caused by that, then it shouldn't be too serious.  Also, can people stop comparing stuff to 2009? 2009 was a unique once-in-a-lifetime circumstance, and not indicative of actual market values. "If we can agree that 2010 was closer to the low of 2009 than 2007 then the rich did all the buying while the super-rich did all the selling. http://www2.ucsc.edu/whorulesamerica/power/wealth.html Looks like the rich cleaned up during the Tech Crash too, but it looks like the poor lost faith. That limited data makes it look like the best investors are the rich. Market makers are only required by the exchanges to provide liquidity, bids & asks.  They aren't required to buy endlessly. In fact, market makers (at least the ones who survive the busts) try to never have a stake in direction.  They do this by holding equal inventories of long and shorts.  They are actually the only people legally allowed to naked short stock: sell without securing shares to borrow.  All us peons must secure borrowed shares before selling short. Also, firms involved in the actual workings of the market like bookies but unlike us peons who make the bets play by different margin rules.  They're allowed to lever through the roof because they take on low risk or near riskless trades and ""positions"" (your broker, clearing agent, etc actually directly ""own"" your financial assets and borrow & lend them like a bank). http://www.finra.org/web/groups/industry/@ip/@reg/@notice/documents/notices/p004001.pdf This is why market makers can be assumed not to load up on shares during a decline; they simply drop the bids & asks as their bids are hit." "In an attempt to express this complicated fact in lay terms I shall focus exclusively on the most influential factor effecting the seemingly bizarre outcome you have noted, where the price chart of VIX ETFs indicates upwards of a 99% decrease since inception. Other factors include transaction costs and management fees.  Some VIX ETFs also provide leveraged returns, describing themselves as ""two times VIX"" or ""three times VIX"", etc. Regarding the claim that volatility averages out over time, this is supported by your own chart of the spot VIX index. EDIT It should be noted that (almost) nobody holds VIX ETFs for anything more than a day or two.  This will miminise the effects described above.  Typical daily volumes of VIX ETFs are in excess of 100% of shares outstanding.  In very volatile markets, daily volumes will often exceed 400% of shares outstanding indicating an overwhelming amount of day trading." This would otherwise be a comment, but I wish to share an image. A stock I happened to own, gapped up on the open to $9.20 and slowly worked its way down to $8.19 where it closed up 6% but near its low for the day.  This is an addendum to my comment above, warning about buying a stock on the open when news is coming out. Or more important, to be mindful of that news and the impact it might have on the stock. In this case, when the news came out and the stock had closed at $7.73, one would need to decide if he wished to buy it at any cost, or place a limit order.  I've redacted the name of the company, as this discussion has nothing to do with any particular stock, I'm just offering an example of the effect I warned about, three weeks ago. (Full disclosure, I got out at $8.70 in the first minutes of trading.) When you buy a stock, the worst case scenario is that it drops to 0.  Therefore, the most you can lose when buying a stock is 100% of your investment. When you short a stock, however, there's no limit on how high the stock can go.  If you short a stock at 10, and it goes up to 30, then you've lost 200% on your investment.  Therefore shorting stocks is riskier than buying stocks, since you can lose more than 100% of your investment when shorting. because the price might go up, but it will never be as big of a change as a regular price drop i suppose... That is not true.  Stocks can sometimes go up significantly (50-100% or more) in a very short amount of time on a positive news release (such as an earnings or a buyout announcement).  A famous example occurred in 2008, when Volkswagen stock quintupled (went up 400%) in less than 2 days on some corporate news: Porsche, for some reason, wants to control Volkswagen, and by building up its stake has driven up the price. Hedge funds, figuring the share price would fall as soon as Porsche got control and stopped buying, sold a lot of VW shares short. Then last weekend, Porsche disclosed that it owned 42.6 percent of the stock and had acquired options for another 31.5 percent. It said it wanted to go to 75 percent. The result: instant short-squeeze. The German state of Lower Saxony owns a 20 percent stake in VW, which it said it would not sell. That left precious few shares available for anyone else. The shorts scrambled to cover, and the price leaped from about €200, or about $265, to above €1,000. While JB King says some useful things, I think there is another fundamental reason why stock markets go down after disasters, either natural or man-made.  There is a real impact on the markets - in the case of something like 9/11 due to closed airport, higher security costs, closer inspections on trade goods, tighter restrictions on visas, real payments for the rebuilding of destroyed buildings and insurance payouts for killed people, and eventually the cost of a war. But almost as important is the uncertainty and risk. Nobody knew what was going to happen in the days and weeks after an attack like that. Is there going to be another one a week later, or every week for the next year? Will air travel become essentially impractical? Will international trade be severely restricted? All those would have a huge, massive effect on the economy. You may argue that those things are very unlikely, even after something like 9/11. But even a small increase in the likelihood of a catastrophic economic crash is enough to start people selling. There is another thing that drives the market down. Even if most people are sure that there won't be a catastrophic economic crash, they know that other people think there might be and so will sell. That will drive the market down. If they know the market is going down, then sensible traders will start to sell, even if they think there is zero risk of a crash. This makes the effect worse. Eventually prices will drop so far that the people who don't think there is a crash will start to buy, so they can make a profit on the recovery. But that usually doesn't happen until there has been a substantial drop. A stopped clock is right two times a day.   We may get a market crash similar to the financial crisis or the dot com crash or we may not. What if over the next 10 years rates rise very sluggishly, low inflation, and  low growth more or less continues with maybe one brief and shallow recession. In that case I bet US stocks produce 4-5% returns per year and US bonds produce maybe 1-2% per year.  European and emerging market stocks should have higher returns because they are in an earlier part of the cycle.  I think your baseline has to look something like that.  The last two crashes were caused by the tech bubble and the housing bubble - where is the bubble today? US stocks are expensive, but probably not in bubble territory. Bonds worldwide are unattractive with low or negative yields - negative yields maybe a bubble, but central banks will be the most hurt by negative rates and they are in a strong position to take the pain.   There could be a crash I just don't see how we get there yet - maybe china? If you're willing to entertain the fact that a lack of any action by the fed would have killed market confidence and caused equities to tank, gold could have been a suitable asset in a flight to quality.  Of course as others have said the drop would just be the uncertainty about QE3 being removed from the price "Asking why the p/e was so high is best answered ""because reported earnings were so low"". Recall that the S&P500 bottomed in early March 2009 when the panic of the financial crisis reached exhaustion.  As noted on the page you have linked, the reported p/e ratios are computed using reported earnings from the trailing twelve months.  During those twelve months the banks were writing down all of the bad debt associated with the mortgage backed securities that has lost so much value.  This meant that the banks were reporting negative earnings.  Since the financial sector is a large part of the S&P500, this alone had an enormous effect on the index p/e.  However, the problem was compounded by a general collapse in earnings across the economy as consumers reacted to the resulting uncertainty.  The same site reports earnings for the previous years at $17.11 for the S&P500, compared to $76.17 for the year prior to 2008.  That is a collapse of about 78% in earnings.  Although the S&P500 has suffered badly during this time, stock market investors being forward looking were starting to price in improved earnings by May 2009.  Indeed, the S&P500 was up about 33% in just two months, from its low in March2009 to mid May2009.  Thus, by May of 2009 prices were not suffering to the same extent as reported trailing earnings.  This would account for the anomalous p/e value reporting in May2009." "The larger macro funds, the ones struggling in this environment, need there to be a""normal"" amount of volatility in the market to make money. They need price action to provide buy/sell points, and to help them spot trends. The one way market we have been in for a long time makes this difficult/impossible. And then when we get two days in a row like we just had, it can really fuck them up and will lead them to take positions of at the worst time. And the loses are larger because all the macro funds use leverage, so a dollar loss could really become $3-6.  The index funds are winning right now, no doubt. But they will have thier day off reckoning too, we just don't know how that plays out...yet.  everyone put active mutual funds in the trash two years ago, and they are having the best year they have had in ages. It's all very cyclical. (Sorry for one paragraph, I'm on mobile.)" If you throw up a 20 year chart on the 10 year you can see it isn't fluctuating around 2%.  It happens to be at 2% now but it has been relentlessly driving lower for at least 20 years.  My own personal biased opinion is that it is a market infested with ultra-wealthy people who aren't looking for returns.  They just basically want to maintain what they already sucked out of the system. "Both explanations are partly true. There are many investors who do not want to sell an asset at a loss.  This causes ""resistance"" at prices where large amounts of the asset were previously traded by such investors.  It also explains why a ""break-through"" of such a ""resistance"" is often associated with a substantial ""move"" in price. There are also many investors who have ""stop-loss"" or ""trailing stop-loss"" ""limit orders"" in effect.  These investors will automatically sell out of a long position (or buy out of a short position) if the price drops (or rises) by a certain percentage (typically 8% - 10%). There are periods of time when money is flowing into an asset or asset class.  This could be due to a large investor trying to quietly purchase the asset in a way that avoids raising the price earlier than necessary.  Or perhaps a large investor is dollar-cost-averaging.  Or perhaps a legal mandate for a category of investors has changed, and they need to rebalance their portfolios.  This rebalancing is likely to take place over time.  Or perhaps there is a fad where many small investors (at various times) decide to increase (or decrease) their stake in an asset class.  Or perhaps (for demographic reasons) the number of investors in a particular situation is increasing, so there are more investors who want to make particular investments.  All of these phenomena can be summarized by the word ""momentum"". Traders who use technical analysis (including most day traders and algorithmic speculators) are aware of these phenomena.  They are therefore more likely to purchase (or sell, or short) an asset shortly after one of their ""buy signals"" or ""sell signals"" is triggered.  This reinforces the phenomena. There are also poorly-understood long-term cycles that affect business fundamentals and/or the politics that constrain business activity.  For example: Note that even if the markets really were a random walk, it would still be profitable (and risk-reducing) to perform dollar-cost-averaging when buying into a position, and also perform averaging when selling out of a position.  But this means that recent investor behavior can be used to predict the near-future behavior of investors, which justifies technical analysis."