We have had flash crashes in equities, Treasuries, and foreign exchange. The three biggest, deepest, and most liquid markets in the world. We may have had a multitude of mini-flash crashes in ETF's, individual stocks, or markets that have significant declines and liquidity shortages over limited time periods. The Monday open price declines for a number of ETF's may qualify as a flash crash although in a different era we may have called just an opening order imbalance. All have the qualities of a short-term order imbalance which leads to a sharp price decline. The order imbalance could just be pulling orders on one side of the market as opposed excessive orders on the other side of the market.
Flash crashes have come and gone so why should we care? The markets have bounced back after these crashes with limited after effects. Except they really don't just jump back to normal. A study from the NY Fed suggests that market depth declines for a number of days after the flash crash; however, we think the impact has even stronger ramifications especially for systematic traders.
If you run a program with stops, your worst nightmare will be for the ammeter to run through your stops only to return to the original prices after a few minutes. You are not being paid to be prudent which changes the complexion of trading. The market integrity is compromised and risk management has to adapt. The adaption will usually entail some reduction in risk taking which will likely hurt performance relative to what would have been produced in the past. Studies have done a good job of showing what happened to the markets around the flash crash but I have not seen a good explanation or model for why these events occur or how they can be forecasted. Fear comes when a phenomena cannot be explained. Flash crashes create market fear.
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