Article The Perils of Program Trading

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On the afternoon of May 6, 2010, the Dow Jones Industrial Average (DJIA) plunged 800 points in less than 20 minutes before recovering most of its losses, creating a new term in the financial lexicon – the “flash crash.” The Dow’s intraday drop of 998.5 points or 9.2% was its largest points decline on record, while its intraday swing of 1,010 points was the second-largest in the history of the index, exceeded only by a 1,018-point swing on October 10, 2008. While the Dow’s temporary swoon during the flash crash was a harrowing reminder of the market collapse after the bankruptcy of Lehman Brothers in September 2008, the culprit this time was not overwhelmingly bearish sentiment but something altogether different – program trading.
What is Program Trading?The NYSE has a rather dated definition of program trading, which it defines as (a) index arbitrage, or (b) the purchase or sale of a basket or group of 15 or more stocks as part of a coordinated trading strategy. Index...

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