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Home » Invest, Market Terminology, Wall Street News

Stock Market Crash of May 6 2010 Highlights a Broken Market

Last updated by on 19 Comments

There are days that question any remaining faith that you have in stock market investing. May 6, 2010 (today for those keeping score) is one of those days. Two odd happenings occurred on ‘the Street’ today that I found very disturbing.

Bizarro Market, Part 1, Stock Indexes Collapse in Minutes as the Computers Take Over

In a matter of minutes, the Dow Jones Average plummeted 1,000 points, nearly 10% of it’s total value. Here’s a look at the Dow chart (the drop happened at about 2:48 PM EST):

may_6_stock_market_crash

We’ll talk about the speculation as to why it happened, but first, watch it happen live on CNBC as the talking heads start to panic:

If I understand what I’ve been reading, this crash was caused not by fear of the debt crisis in Greece or other legit economic indicators, rather, it was caused by algorithmic trades that automatically kicked in when the market index dropped below it’s 100-day and 200-day moving averages.

For anyone who was 100% invested into one of the major stock indexes today, at one point you lost 10% of your net worth, your life savings, because investors had passive, indiscriminate computerized trades ready to go and execute based on an algorithm.

Is that less than absolutely frightening for anyone with money in the stock market? Yes, the market did rebound and ended the day down a mere 347 points, but there were undoubtedly many who bailed on the collapse much lower than that.

Bizarro Market, Part 2, Proctor & Gamble

The other really bizarre thing that happened today was the shares of blue-chipper defensive buy Proctor Gamble (PG), dropping over $22 (or 37%) almost instantly. Nobody really knows what happened, but it has been speculated that someone entered a trade that was an error. Too many zeros, if you will. Instead of 1,600 shares, they accidentally tried to sell 16 million or so. Oops!

Really?

Where do we go from here?

I know that in order to beat inflation I need to invest my money in some form of equity. But days like these really question my faith towards the stock market and what media and technology has turned it into. I don’t want my life savings, years of determined hard work to vanish instantly due to media panic or computer generated algorithmic trades.

Do you?

I’m off to look into that EverBank Diversified Metals CD a little more closely.

What’s your taken on the market? Is it completely broken? Where are you putting your money?

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I am G.E. Miller, & this is my story. My goal is financial independence ASAP. If you share that goal, join me & 7,500+ others by getting FREE email updates. You'll also find every post by category & every post in order.


19 Comments »
  • Jeff Walden says:

    At one point you lost 10% of your net worth, your life savings, because investors had passive, indiscriminate computerized trades ready to go and execute based on an algorithm.

    The “algorithm” isn’t some unseeing, uncaring automaton; it’s something written by people, according to their desires about how and when to trade. Also, it’s not “an” algorithm, it’s the judgments of many, many different algorithms written by many, many different people. Price changes, as ever, reflect the views and positions of investors (or their proxies) in the marketplace. In each case someone knowingly made a decision that they thought it prudent to sell after a sufficiently large drop (also, probably, given the rebound today, to buy after a sufficiently large drop to capitalize on momentary irrationality). None of the dozens of pieces of software involved in making this post would exist absent the direction and intentions of hundreds of different people; the same is true of the software that automates realtime investment decisions.

    I’m not touching any of my investments (not that I really could, since everything outside bank accounts is in IRAs or 401(k)s where I’m pretty sure I’d incur penalties trying to sell them). Nor, really, should anyone in the ostensible target audience for this site. The momentary blip of a few minutes, a few hours, a few days, or even a few years isn’t hugely important when you think that 20-somethings have a couple few decades to wait out downturns. Not to mention, of course, we’re still 60% above the lows of last year.

  • Paul says:

    If anything its an excellent time to buy…

  • G.E. Miller says:

    Not saying it’s a good time to sell or a good time to buy, so don’t get me wrong here. What I’m saying is that our markets are having incredibly volatile days like this that have nothing to do with fundamentals and everything to do with trades that are automatically triggered algorithmically. The founder’s of our stock markets would be flipping in their graves. It’s incredibly dangerous and threatening for amateur investors who don’t have the stomach for long-term patience (and even those who have had patience over the last decade haven’t made a dime in the markets). Is this really the way our markets should operate? Hedge fund managers/day traders/Wall Street insiders are getting very rich, but is the average Joe growing net worth at all anymore? Something has to fundamentally change in how the markets operate. I can’t be the only one who feels this way.

  • G.E. Miller says:

    @ Paul – good points. I just hope for your sake and mine that the wave ultimately ends up being higher in the end than right now. 12% annual gains over time are a thing of the past. I guess the melting ice caps should help raise the waves. =)

  • Paul says:

    You certainly are not. This is the part of the issue with automatic buy/sell orders. I mean Accenture falling to 1 cent?!? Talk about insane.

    from a business week article this morning: “Somebody hits the wrong button and everybody heads through the same door at the same time,” said David Goerz, who oversees $17 billion as chief investment officer at Highmark Capital Management in San Francisco. “It clearly was a factor. When you have a lot of skepticism and nervousness in the market place, that just exacerbates the problem.”

    It hits the nail on the head – we need more humans and logic back in the process and there needs to be methodology put in place to prevent this type of issue. It reminds me of the old story when a commodity trader screwed up and got an order delivered to his office.

    Who wins and who loses? Well it is obvious. I just hope by being patient, conservative, and smart that I will be able to ride the wave for the next 80 years.

  • Paul says:

    Haha!

    I think it all circles back to the post you wrote a few months back about retirement. All of this goes hand in hand with the fact that retirement has to be rethought.

    If I can keep up with inflation and continue save the way I (and I would imagine all of your readers) need to be saving, then I think that guys like us have a future of consulting and relative prosperity.

    It is a totally different line of thought/way of life than our parents or grandparents, but it I personally find it more attractive than shuffleboard in the home!

  • Budgeting in the Fun Stuff says:

    I personally take advantage of market volatility and assumed most individual investors would. We bought $1000 of discounted Conoco yesterday and $1000 in Intel the day before. We would invest more, but that’s all we had that was put aside for the stock market.

    Sure, it’s scary when the market crashes (especially due to automatic buys or sells), but that’s not just available for big business. My husband does most of our buying and trading based on preset automatic buys and holds because we aren’t home during the day…big business just can be more scary since they have so much more money. I’m not going to hold that against them though. If I were in their shoes, I’d use whatever legal methods were available to maximize profits as well.

    This is coming from someone who’s net worth just took a big hit on individual stocks and mutual funds…I understand that it sucks and is scary, but the market will come back. Buy Low and Sell High is a well-known tip for a reason.

  • GE Miller says:

    @ BIFS – when individual investors start trying to time the market and ‘buy low’ and ‘sell high’ that’s when things can get out of control. The market was already down 4% this morning for instance before rebounding completely. Where’s ‘the low’ and where’s ‘the high’ right now?

  • Bill says:

    Are you guys retarded? our market crashed yesterday and the only reason you seen the slight recovery was due to an “under the table bailout!” nothing wrong with being in the stock market but more people need to quit treating it like an investment because it’s not investing anymore it’s gambling. The reason it’s gambling now is because the whole system is manipulated!!! How can you be “invested” in a market that people claim “ohhhh the computer is messin up on us” bullshit!

  • Aaron says:

    “we need more humans and logic back in the process and there needs to be methodology put in place to prevent this type of issue.”

    Example #1 was a computer algorithmic problem, and the second one is suspected to be a human problem.

    As a network engineer, I go through the same debate between automating processes with scripts vs doing things by hand. You have some who insist they not use a script for fear of unintended consequences of the script, but then others who insist scripts are the way to go to reduce human error.

    It’s all about what the human or the automated process is doing in this case. My issue with the microbuying is it appears to me be automated stock speculation. I don’t care how speculation is done, via human or machine, but it artificially drives prices up, which inevitably leads to market corrections.

    If anything, the only common thread between these two issues was a consolidation of power between the automated processes which obviously operated with similar logic, and the person behind the order who fat fingered it.

  • John says:

    While your are correct that computer trading contributed to the sell off, I think you do yourself a disservice by ignoring the fundamental backbone of this correction, and that there still remain many indications that the market is still to move down.

    If you can get away from the gov’t message cnbc and move to more independent financial advice shows, you would hear that there have been a number of key technical indicators predicting this move. In fact Tom Obrien of TFNN called this as recently as Wednesday on an interview with Woody Vincent.

    This crash is not a phenomenon of the current trading method, we have seen them before. So don’t write-off the market signs because it is convenient to blame modern technology. Those who ignore history are doomed to repeat it.

  • Paul says:

    The overall drop from yesterday is not the issue – it is the temporary 1000 point drop and the issue with stocks like Accenture and Samuel Adams dropping to 1 cent and ZERO respectively. Those are either a tech problem or a methodology problem (fat fingers, no second verification).

    What technical indicator showed that those two companies (who are doing very well) are worthless?

  • Wayne Walter says:

    Paul,

    Technically, the only reliable way to invest in stocks is to purchase the dividends. That is, you buy the stock without any intention to ever sell it. So the price of the stock becomes irrelevant after you purchase. Instead, you collect the dividends every year from solid, profitable companies.

    That means you only value stocks by the P/E ratio to their dividends and your own confidence the company will continue to pay the dividends.

    Stock certificates themselves have zero intrinsic value. In other words, it’s completely valid for them to go to a zero value even if they pay good dividends because other people may simply not want to purchase it now for any number of possible reasons.

    Stocks are unlike commodities like which definately have intrinsic value and will never possibly go to zero. Someone will always be willing to purchase beef, O.J., oil, at some price–far more than zero.

    A similur problem exists with currencies which are not backed by any thing of value other than confidence in the issuing country’s economy.

    Once you buy dividends (not stocks) at a good price that will return on your investment over many years, who cares what the current price is? And who cares if the stock is volatile or has “flash crashes”?

    Wayne

  • BIFS says:

    GE Miller, I see “low” and “high” in terms of the price we invested at. We’re young and can buy and hold for quite a while.

  • Aman@BullsBattleBears says:

    @ BIFS, being young does not necessarily mean you have a longer time. Some people I work with are young and use short term spikes to make money to pay down loans, generate down-payments for a purchase on their first home or car. Its too much of a generalization to say a young person has more time.

    The main drive to be in the markets is to make money and beyond that, the time frame at which you want to get in and out is individually set.

    Personally, until Greece and more importantly, Spain is sorted out, markets will continue to peg lower since there are lingering jitters from the previous debacle of the housing markets and financial sectors.

    Will this be the same? worse? who knows. Nobody has the magic 8-ball to predict the outcome…its all about your risk tolerance and ability to put emotions aside and make strategic trades.

  • John says:

    “It’s incredibly dangerous and threatening for amateur investors who don’t have the stomach for long-term patience (and even those who have had patience over the last decade haven’t made a dime in the markets).”

    PATIENCE is key here. If you have the time to follow the markets closely then you can make some money in small caps, large caps during earnings, and options. That being said, withouth the stomach you need to stick with diversified Utilities with histories of dividend growth like EXC, SO, and FPL, and good staple stocks like JNJ, MCD, MO. If you want to be risker then run screens for undervalued small caps at finviz or use the research at microcapreports

  • DCDA1312 says:

    I guess when you think the stock market is your only investment option that it is the only place you will invest. When the market crashes what happens is that 90% of the people share 10% of the money and the other 10% of the people share the other 90% of the money. The stock market is the worst place to invest. People are now watching their retirements go up in smoke based off other people’s decision making and not their own. The stock market is the government’s form of legalized gambling. Do you really want to gamble with your retirement? I mean how naive do you have to be. People are too lazy to go out here and create their own retirement. They want their investor to do it all for them. You have no idea when you are going to die. How would you know how much to save even if the stock market did work? 401K’s and IRA’s where never designed to be retirement accounts. But I guess you wouldn’t know that if no one told you. Do your research. You are only making the rich richer by putting your money in the stock market. When you can’t retire, just remember you read this and that someone tried to tell you so (or the truth).

  • Aury (Thunderdrake) says:

    Man! I remember watching that DOw crash live when I was on twitter. My apps certainly painted me a scary picture when that happened. Furthermore, I’ve been quite bearish of the stock market since.

    I currently own a few dozen dividend stocks, so I don’t speculate or gamble on my holdings. Instead I try to keep myself vested for cash flow, in which dripping steady dividends will empower it in the future.

    It’s important to note though, that if you want a safe haven for your money, commodities is always the place to be. Stocks are volatile, and very risky, but that’s where the gains come in. When in doubt, look forwards to hedge yourself. Inside the market, buy options. Outside the market, commodities.

  • Robert says:

    I see “low” and “high” in terms of the price we invested at. We’re young and can buy

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