Iron Capital Insights

  • Iron Capital Insights
  • May 6, 2010
  • Chuck Osborne

What Does This Button Do?

Just after 2:30 p.m. today one of our analysts stormed into my meeting to tell me the market had just plunged 8% in a matter of minutes. At first I thought he must be wrong. I have been through some big market declines, but this was the biggest thing since 1987. Indeed, the Dow had tumbled nearly 1,000 points in just a matter of minutes.

Immediately the 24-hour press had to have something to blame it on, so literally as it was happening, they pointed to Greece. This makes no sense. Don’t misunderstand, the situation in Greece is serious and certainly will not help the markets, but it is not going to cause the market to drop at superhuman speed.

As we were preparing to do what we could to protect your portfolios from any potential future damage, the market started coming back, almost as quickly as it had dropped in the first place. We were watching the chart of the S&P and it started to form a picture we have seen many times before…this was a trading error. Sure enough, as I am writing this, CNBC is reporting that it was an error made by a trader at Citigroup. Bloomberg is saying that according to NYSE Euronext, there were numerous erroneous trades.

Trading errors happen more frequently than most people realize. Usually it impacts only one stock, not the whole market. How it happens is simpler than it seems. Someone puts one too many (in this case it may have been two or three too many) zeros on a trade ticket, and lo and behold, prices move in dramatic fashion. The price movement also can trigger automatic trading, which can exacerbate the effect of the error.

The firm responsible has to pay to fix it, so once they notice it, they act as quickly as possible to correct it. The prices go back to where they were before the error as quickly as they moved away. If this was the fault of an error, it may be the most costly trading error in history. Some poor – soon to be unemployed – trader will be able to tell his grandchildren that his carelessness caused the most volatile 30 minutes in stock market history.

In the meantime, the real downward pressure in the market, which is much less severe, looks more like a technical correction in the midst of a bull market than anything to lose sleep over right now. Of course we will stay vigilant.

Chuck Osborne, CFA
Managing Director