Flash Crashes Explained

Discover what flash crashes are, why they occur, and how they impact financial markets. Flash crashes are sudden, rapid declines in asset prices that often recover quickly, highlighting the effects of automated trading, low liquidity, and market volatility. Understanding these events helps investors recognise potential risks and implement strategies to protect their investments during extreme market fluctuations.

A flash crash is a sudden, deep, and rapid decline in the price of a security or multiple securities, often followed by a quick recovery. These events usually last minutes or even seconds and can be triggered by automated trading systems, low liquidity, or market panic. Flash crashes highlight the risks associated with high-frequency trading and the importance of market safeguards.

Example: A stock trading at ₹1,000 may suddenly drop to ₹900 within minutes due to a flash crash before recovering back to ₹995 once the market stabilises.

Flash crashes typically occur when a large volume of orders overwhelms the available liquidity in the market. Key steps include:

• Automated trading systems place large sell orders rapidly.
  

• Prices fall sharply as available buy orders are exhausted.
  

• Panic selling by traders accelerates the decline.
  

• Prices often rebound quickly once sufficient buyers enter the market or trading halts are triggered.
  

Numeric Illustration: If Stock A is trading at ₹2,000 per share, a sudden automated sell order of 50,000 shares may push the price down to ₹1,800 within minutes. Once the sell pressure eases, the price can recover to ₹1,950.

Several factors can contribute to flash crashes, including:

• High-frequency trading executing massive volumes within seconds.
  

• Thin liquidity makes markets sensitive to large orders.
  

• Stop-loss cascading, where automated triggers accelerate selling.
  

• Market panic or overreaction by traders.
  

• Technical glitches or errors in trading algorithms.
  

Example: A thinly traded stock priced at ₹500 receives a large automated sell order of 20,000 shares, causing it to briefly fall to ₹400 before rebounding to ₹490 as buyers step in.

This numeric illustration demonstrates how sudden order imbalances and automated trading can create sharp, temporary price movements that define flash crashes.

Flash crashes have occurred in various markets and provide insight into how quickly prices can fall and recover. 

• Example 1: During the 2010 US Flash Crash, the Dow Jones Industrial Average dropped nearly 1,000 points within minutes before rebounding.

•  Example 2: A single stock trading at ₹1,200 may suddenly drop to ₹1,050 due to a large automated sell order, then recover to ₹1,180 as liquidity returns.

These events highlight the importance of market safeguards, monitoring, and risk management to protect investors from sudden losses.

Flash crashes can impact multiple asset classes beyond equities. These include:

• Stocks and ETFs where high-frequency trading dominates.
  

• Futures and derivatives with leverage that amplifies volatility.
  

• Currencies and commodities, particularly in less liquid markets.
  

Numeric Illustration: If a stock is trading at ₹2,000 per share, a sudden large sell order of 50,000 shares may push the price down to ₹1,800 within minutes before recovering to ₹1,950 once normal trading resumes.

Flash crashes illustrate the speed and complexity of modern financial markets. Prices can decline sharply in minutes but often recover quickly as liquidity returns. Understanding these events helps explain the risks associated with sudden market volatility and highlights how different market types may be affected.

This content is for informational purposes only and the same should not be construed as investment advice. Bajaj Finserv Direct Limited shall not be liable or responsible for any investment decision that you may take based on this content.