1. sufficient assets to cover the margin on multiple and massive short sell orders.
2. high frequency trading access to the market using computer controlled trading.
3. historical data on the various DOW stocks that would allow me to predict how many of their shares are likely to be covered by stop-loss sell orders. Historical data on the number of stop loss orders executed in the past and the percentage drop that caused them to execute would be ideal.
4. a day will particularly weak and low volume trading.
5 optional: sufficient assets to cover multiple and massive buy orders prior to the initiation of the short selling blitz.
My program to recreate the crash would monitor all the DOW stocks and continually track the total buy orders outstanding between the market price and track the total number shares I would have to sell in a market price order to take out all the buy orders between the current price and various target prices below that. The program would match this data with the best estimates for how many stop loss orders would occurr at those same target prices.
Given a weak trading day like May 6th there would be a tipping point at which the number of shares sold (short) at market price would virtually guarantee that enough stop loss orders would execute to immediately cover all the short sells at whatever price the program decided was likely to yield the highest profits.
Once the tipping point is reached for enough of the Dow components the program executes and the flash crash begins.
1. prior to initiating the short sell orders the program would enter buy orders for all the stocks involved equal to the number of shares that are going to be sold. The buy orders would have a limit price equal to the target price that the short sell orders will cause the stock to drop to.
2. Short sell orders at market price are executed for the all the target stocks.
3. These market price sell orders take out ALL outstanding buy orders that are higher than the limit buy orders in step one, causing the new market price to be equal to whatever the limit price of my buy order is.
4. ALL stop loss orders between the previous price and the price of my limit order immediately execute and go to filling my limit price buy order.
5. Very quickly my buy order is completely filled and I have successfully covered all my short sell orders at prices considerably lower than I initially sold for.
6. After the buy order has been filled there will no doubt be additional selling caused by the panic as well as even more stop loss orders executing causing the stocks to drop even further. For stocks where the demand was particularly weak and/or my program underestimated the number of stop loss orders that would execute the price might very easily drop to a penny a share.
I know this is an oversimplification of the situation but as far as I know there is nothing to prevent people with sufficient resources from manipulating the market in the way that I have described. The New circuit-Breaker rules for individual stocks are not the solution. The new rule basicly is going to limit this sort of market manipulation to 5% chunks at a time while at the same time making those stocks less liquid because the rules will stop trading for ALL investors both short and long if the circuit breaker trips.
Personally I am NOT ok with limiting market manipulation to 5% increments at a time when it can be eliminated entirely simply by bringing back the uptick rule. There are alot of traders out there who view the stock market as one vast piggy bank holding unimaginable wealth. As long as the SEC provides these traders with all the tools that they need to legally raid this piggy back who is dumb enough to think that they will ever stop?
Brining bask the Up-tick rule would absolutely without a doubt eliminate the use of short selling to manipulate stock prices and it is dismaying that that topic is not even up for discussion. It would seem that the people reaping the benefits must also be generously investing their profits in seeing that their access to the Piggy Bank is not cut off..