Today a number of stocks had a mini flash crash exactly one second before the market opened. The affected issues:  C, HPQ, T, WU, HES, WFC, KR, VTR, GS, S, RAI, WMB, CRM, IBM, LUK, & TAP

HPQ traded as low as $3.06 as you can see on the tape:

Today’s flash crash in these issues was caused by market fragmentation and inefficient order routing. These sudden market moves were caused when an order was routed “direct” to the Nasdaq (NSDQ), bypassing liquidity on the other exchanges.  SEC rule 611, the order protection rule, is designed to prevent “trade-throughs”, which are trades being executed at prices inferior to the best-priced quotations.  But this rule only protects the top of the order book, and the rule does not cover the pre-market trading session.

To better understand SEC rule 611, consider the following example:

Security ABC order book on Ask:

Size     Price    Exchange

300      25.00   BATS

300      25.02   ARCA

300      25.03   NSDQ

NSDQ receives a market order to buy 600 shares of security ABC.  The best available offer is on the BATS exchange at $25.00.  NSDQ must route the first 300 shares to BATS because this order is at the top of the order book and is a “protected quotation” under SEC rule 611.

But here is where it gets interesting.  Having satisfied the order protection rule by routing the first 300 shares to BATS, the remaining 300 shares is now routed back to NSDQ and executes against the NSDQ’s $25.03 quotation.  The $25.02 offer on ARCA remains unfilled.  In other words, the ARCA order is traded through.

The participant sending the order actually gets an inferior price being filled at $25.03 on NSDQ when they could have been filled at $25.02 on ARCA, but the $25.02 ARCA quote (because it was not at the top of the book), is not a protected quotation and not covered by SEC rule 611.

In today’s example, the trades occurred during the pre-market session, so even the top of the book is not protected.  With market liquidity being fragmented across multiple exchanges, order depth on one specific exchange can in some instances be pretty sparse, especially during the pre-market session. Sometimes directed orders are large enough that they can sweep through multiple levels on the exchange, causing the stock to have a sudden fall in price on that specific exchange.

This is what happened today on these 16 symbols.  As you can see, it is very important to route your orders carefully in this fragmented market structure.

Note – Nanex has done an excellent job at analyzing the details of today’s flash crash event.  You can view it here:

Nanex analysis of December 13th flash crashes