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Flash crash revisited

By Sheyna Steiner · Bankrate.com
Friday, January 14, 2011
Posted: 10 am ET

Investing is not always as straightforward as it seems. As some may recall, the world of high-frequency trading was thrust into the spotlight last May when the Dow Jones plunged nearly 700 points in just a few minutes.

The Securities and Exchange Commission investigated the incident and traced it back to one large sell order of E-Mini Standard & Poor's 500 futures contracts placed by a high-frequency trading algorithm from a mutual fund company.

Financial journalist and Reuters blogger Felix Salmon wrote an article for Wired Magazine called "Algorithms take control of Wall Street" for the January 2011 issue. It's available online as well.

Yesterday, Salmon was on NPR's Fresh Air to discuss the article and the May 6 flash crash. The interview is quite interesting.

My favorite part of the interview was when Salmon explained that there are things going on behind the scenes that make the stock market even trickier for individuals to navigate than ever before.

"We don't understand what causes individual stocks or entire market indices to move. We have an incredibly complex system with only the most rudimentary controls. And we got a hint of what could happen last May, during the flash crash, but we have no idea what other things might happen," Salmon said in the NPR interview.

In a Kiplinger.com article from October 4, 2010, "Lessons from the May 6 flash crash," Anne Kates Smith explained how individual investors can try to protect themselves from unseen forces impacting the markets.

"The safest way to trade in today’s markets is with limit orders on everything, starting yesterday," Smith wrote.

A limit order allows you to set the price at which a security should be bought or sold. For instance, a buy limit order would specify the highest price a trader might wish to pay, and a sell limit order would indicate the lowest level at which the sale should go through.

It's not always guaranteed, however. From the SEC:

"Remember that your limit order may never be executed because the market price may quickly surpass your limit before your order can be filled."

To learn more about trading strategies that may protect your investments, read the Bankrate feature, "3 ways to reduce stock losses."

Have you ever been caught in short-term market volatility? What happened?

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