I'm not Jeff but perhaps I can provide some insight into the flash crash.
Also, what IS algo trading?
Is a margin call algo trading? Is a stop loss algo trading? What about technical analysis?
(Flash) crashes should be expected anytime you over leverage your entire economy.
See: George Soros and the pound.
Imagine everyone you know has widgets, and you realize that most people like to keep their widgets in a warehouse. You setup a warehouse that stores widgets and people pay you to store their widgets. Everyone loves it, no more widgets around the house cluttering things up.
Now since the widgets are identical and interchangeable you stop tracking whose widgets belong to who and throw them all into a big pile, and when someone asks for their 20 widgets you give them a random 20 widgets.
Now you realize that keeping all these widgets around is a massive waste of time and money since only about 1% of widgets are actually in use before being returned to the warehouse. So you tell your customers, "hey, I'm not going to bother actually keeping all the widgets, and I'm going to stop charging you to store your widget and instead I'll pay you to keep your widgets, if you store your widgets for a year I'll give you an coupon you can bring back to me at the end of the year and I'll give you all your widgets back plus 10% more".
This system works great and everyone is happy, after a few decades the coupons for the widgets outnumber the widgets by a factor of 10,000.
Now some asshole with a basic grasp of mathematics invents a computer program to manage widget coupons and it realizes that if it buys 1/10000th of the widget coupons and redeems them for widgets that no one else can actually redeem any other coupons. So your computer takes delivery of all the widgets in the world and then redeems one more widget coupon and everyone loses faith because the coupons for widgets no longer get you widgets and suddenly widget coupons are only worth 1/10000th of a widget. Suddenly everyone is mad at the guy with the computer and basic grasp of mathematics because their widget coupons only buy 1/10000th of a widget, and he's making bank selling everyone their widgets back.
Is the cause of the devaluation of widget coupons the fault of the algorithm, or the fault of the system that allowed more coupons than there are widgets?
The 2010 flash crash was caused by "blackhat" HFT traders trying to game the system.
It was shown that one, some, or many HFTs were involved in "quote stuffing" which is bidding for stock and then pulling the order, something like 100k times per second. This gave the appearance of liquidity and demand, but it was fake, because as soon as someone would bid for the stock, they would pull their order. But another use of this was to essentially slow down the "ticker tape" of the NYSE. What was happening was that the "ticker tape" that showed the current bids and asks was slowing down, and by doing this, some HFTs could make use of the latency arbitrage. Colocated HFTs got their quotes for the best bids and asks directly from the exchanges, but other people were getting their quotes from the NYSE, so they were behind. I believe they were something like 30 seconds behind, so what would happen is that the HFTs had full reign to take advantage of others being blinded like this.
Of course, the side effect of this was that they "broke" the markets. Because of this latency, the NYSE suspended the markets temporarily, which then had the unintended consequence of forcing all the bids and asks to flow into the smaller exchanges, which didn't have the liquidity to handle the orders. There were so many sell orders, that basically all the buy orders for some stocks got taken out, causing the prices to plummet down to 1 cent or something like that.
I'm expecting another flash crash to occur at some point, so whenever I see heated market action, I place a bunch of trades around 25% below the current stock price, which I believe is just above the limits that the exchanges would use to roll back bad trades. (Un)fortunately, it hasn't happened yet, but I'm sure at some point it will.
All HFT is blackhat, leeching off flaws in the way the market clears. There's no legitimate value to be offered by interposing between a buyer and a seller who are in the market simultaneously and would have done the trade unhindered. Traders are a net win for society if they cause better resource allocation, not the same allocation a fraction of a second sooner thanks to a greater misinvestment in network hardware.
Batches of buy and sell orders which are in the money should be executed hourly. The fundamental values of companies don't change more quickly than that. The rest is noise, not signal.
> I place a bunch of trades around 25% below the current stock price
Funny, we sat around trying to figure out the right price and this is what we came up with as well.
Too bad this doesn't show up in second level quotes, it would be a good leading indicator of what funds in general thought the chance of a crash was on any given day:)
I place a limit order, which I guess you could see if the depth were deep enough, but I could very well have programmed an algorithm to just monitor the prices and do market orders instead, which you definitely wouldn't see. I'm sure most traders do it that way.
The interesting thing is that on the day of the Flash Crash, if I'm not mistaken the ES futures contract bounced exactly off the 200 day MA. So, one thing that the flash crash revealed is a lot of algorithms programmed into the markets that would normally never have been revealed. So if you want, keep a floating order just above the 200 day and you might make a few dozen points in a few mins, just like May 6, 2010!
I guess you aren't the only one who started putting in trades within a reasonable margin around the market price after the flash crash. Thus it will be hard to repeat like that.
Perhaps a flash crash could happen in the other direction as well? I.e. flash boom, maybe by squeezing the shorters? In that case buying way out of money call options and putting in automatic orders to sell those options if the stock price goes 50% (or so) over last minute's market price would be a viable strategy?
There was something similar to this in August 2007. A bunch of quant shops blew up, and I believe if you look at the volatility index, it spiked up hugely during this time.
