Flash Crash Definition
A Flash Crash is a sudden, severe, and swift drop in the price of a particular asset, most commonly in financial or crypto markets, followed typically by an equally rapid recovery. It is often triggered by a series of events or algorithms, rather than fundamental news events.
Flash Crash Key Points
- It represents a very rapid drop and recovery in asset prices.
- Flash Crashes occur due to algorithmic trading, high-frequency trading (HFT) glitches, or cascading stop-loss orders.
- The most infamous flash crash occurred on May 6, 2010, in the US stock market.
- Cryptocurrency markets have also witnessed flash crashes due to their relatively illiquid and volatile nature.
What is a Flash Crash?
A Flash Crash is an abrupt drop in the price of an asset within a very short time span, often within minutes or even seconds. The drastic plunge in price is often followed by an equally swift recovery, returning to its pre-crash level. It signifies the high volatility and instability that can exist within financial or cryptocurrency markets.
Why does a Flash Crash occur?
A flash crash typically happens due to a perfect storm of events rather than a single trigger. It could be the result of algorithmic trading, where automated systems start selling off assets due to pre-set conditions being met. A glitch in high-frequency trading (HFT) systems could set off a cascade of sell orders, leading to a rapid drop in asset prices. Another potential cause could be cascading stop-loss orders, where an initial drop in prices triggers a series of stop-loss sell orders, plummeting the price further.
Where can a Flash Crash happen?
While flash crashes are more commonly associated with stock markets, they can occur in any marketplace where assets are traded. The infamous May 6, 2010, flash crash occurred in the U.S. stock market, resulting in a 1,000 point drop (roughly 9%) within minutes on the Dow Jones Industrial Average. Similarly, cryptocurrency markets have experienced flash crashes due to their illiquid and volatile nature.
When can a Flash Crash happen?
A flash crash can happen anytime but is most likely during periods of high market volatility. These events are typically unpredictable and occur swiftly without warning. The speed and severity of a flash crash make it extremely difficult for traders to react or take preventative action.
How does a Flash Crash affect the market?
Flash crashes can impart extreme volatility and uncertainty within the market. They can wipe out billions in market value in minutes, triggering panic-selling amongst investors. Conversely, they also present opportunities for investors who are equipped to take advantage and buy during the rapid price drop. Despite the rapid recovery that typically follows a flash crash, they can discourage market participation by amplifying perceived risk.
