Extreme price movements in UK equities

27 June 2018

It’s not always easy to pinpoint the cause of a flash crash. But trade data gives us a good picture of what happens during periods of extreme price volatility. 

In February this year, a record intraday fall in the Dow Jones stock index prompted a flurry of questions about market volatility.  In particular, what triggers flash crashes in equity prices and why does an initial spark lead to extreme price movements in the market?

To address the second question, FCA researchers analysed a large sample of mini flash crashes and rallies in the UK equity market (PDF). Drawing on data covering all orders and trades on the UK’s major trading venues. This work suggests two key themes related to the behaviour of different participant types during the disruptions.  

First, in relation to trading behaviour, large investment banks appear to drive the extreme price movements - trading aggressively in the direction of the price change. Interestingly, high-frequency traders (HFTs) tend to do the opposite – at least at the start of the price move - by leaning against the wind and trading against the direction of the price movement. A finding that reflects recent analysis by the FCA of the 2016 Sterling flash crash.

Large investment banks appear to drive the extreme price movements - trading aggressively in the direction of the price change.

Eventually, however, HFTs follow the large investment banks and trade in a way that exacerbates the initial price change. Albeit they account for only a small share of this trading.

Second, both HFTs and investment banks provide liquidity during flash events. But they do not make it available quickly enough to meet demand. Liquidity is consumed at a faster rate than it is brought to the table.

HFTs in particular – do not provide this new liquidity at the best available price. In fact, they widen their bid-ask spreads (the difference between the price at which they offer to buy vs. sell). They do this to limit their risk, but this worsening of spreads can contribute to the intensification of the initial price movement.

Overall, the research finds that HFTs are not the biggest contributors to mini-flash crashes and rallies in UK equities markets. Ultra-fast traders play a role, but it is the trading patterns of big investment banks that give the most oxygen to price shocks during these events.

Get Insight in your inbox