On 6 May 2010, US equity markets experienced one of the most dramatic intraday dislocations in their history. Within the space of approximately 36 minutes, the Dow Jones Industrial Average fell by nearly 1,000 points — at the time, the largest intraday drop in the index's history. Trillions of dollars of market value evaporated and then, almost as quickly, recovered. Individual stocks briefly traded at absurd prices: some fell to near zero; others spiked to tens of thousands of dollars per share.
The context and trigger
Markets were already unsettled that day, with significant European sovereign debt concerns driving volatility. A large sell order entered into the market by a single asset management firm — using an automated execution algorithm set to trade by volume rather than price — began a chain of events that the market's structure was ill-equipped to handle.
How the cascade happened
The large, indiscriminate sell order absorbed liquidity faster than market makers could replenish it. As prices fell, automated trading systems began withdrawing or reducing their market-making activity — the conditions were too uncertain to hold large inventories. High-frequency traders, who collectively provide a large share of equity market liquidity in normal conditions, began stepping back from the market.
With liquidity draining, prices moved with extreme speed. Automated stop-loss orders triggered, creating further selling. The feedback loop between price falls, automated responses, and liquidity withdrawal compressed into minutes what would normally take days.
The investigation and response
Regulators — the SEC and CFTC — conducted an extensive joint investigation. The findings highlighted the concentration of market-making in automated systems, the vulnerability of interconnected electronic markets to rapid liquidity withdrawal, and the role of 'stub quotes' (placeholder quotes at extreme prices that were never expected to trade).