May 6, 2010, may long be remembered as one of the most significant events in the young history of electronic trading. As has been widely reported, at about 2:15 p.m. EDT on that Thursday, several financial indexes experienced a sudden and precipitous drop, losing around 8 percent of their value at the beginning of the day in a matter of minutes. The market recovered much of that loss quickly but closed the day down overall.

While there has been no definitive cause identified for the day's events, many financial market experts have identified the increasing presence of automated trading and electronic exchanges as a key cause of this "flash crash." The New York Times explained the importance of the new automated regime as follows:

In recent years, what is known as high-frequency trading--rapid automated buying and selling--has taken off and now accounts for 50 percent to 75 percent of daily trading volume. At the same time, new electronic exchanges have taken over much of the volume that used to be handled by the New York Stock Exchange.

In fact, more than 60 percent of trading in stocks listed on the New York Stock Exchange takes place on separate computerized exchanges.

Complex adaptive systems and unexpected behaviors
High-frequency trading is performed by automated systems that attempt to beat out competition to the best matches of buyers and sellers for particular stocks. These systems are deployed in the same data centers as the exchange systems themselves, and the success of a system is often dependent on shaving milliseconds off of network and computing latencies.

What is critical to note, however, is that the number of high-frequency trading algorithms operating independently against the same market environment creates a sort of complex adaptive system, in which many interdependent agents adhering to known rules create a system which exhibits unpredictable or unexpected behaviors as a whole. In fact, financial markets are often heralded as one of the best examples of complex adaptive behavior.

One of the key traits that science has determined about these systems is that sometimes little causes can trigger giant effects. Think of a pile of sand on a table top. Drop one grain at a time on that pile, and you'll note not a gradual shift in the shape of the pile, but rather moments of relative quiet punctuated by noticeable avalanches. Eventually, one grain of sand triggers an avalanche that sends many grains to the floor.

This is what is assumed by some to have happened in the "flash crash." One unexpectedly big trade seems to have triggered several automated systems to begin selling stock. Attempts to halt the drop by halting trading for specific stocks on the major exchanges were thwarted by continued selling on the new electronic exchanges but probably confused the high-frequency trading systems further.

The result: about 800 points shaved off of the Dow in less than 30 minutes.