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Posted on 25 April 2013 | 3,661 views

Fake Tweets can Cause a Stock Market Crash

At 1:07 p.m. on Tuesday April 23, 2013 — the Twitter feed of the Associated Press told us that Barack Obama had been injured in an explosion at the White House. The tweet was fake — the product of a hack — but given the events in Boston last week, the news spread like wildfire, garnering more that 4,000 re-tweets.

The AP quickly addressed the situation, suspending it’s Twitter account, and alerting readers through associated accounts that the tweet describing an explosion at the White House was the result of a hack. No harm, no foul, right?

Well, not exactly. According to the Financial Times, that one tweet sent shock waves through the stock market — causing the S&P 500 to decline 0.9% — enough to wipe out $130 billion in stock value in a matter of seconds. The market quickly recovered that value, but the breakneck pace at which the stock market tumbled reminded many people of the infamous 2010 “Flash Crash,” or last year’s crisis at Knight Capital Management, in which a computer glitch cost the firm $440 million and nearly sent it into bankruptcy.

Both of these events were caused by the proliferation of high-frequency trading, or the practice of Wall Street firms using high-powered computers to execute thousands or millions of trades per second, making miniscule profits — that add up in a big way, on each trade.

How do these computer programs do this? High frequency traders compile a list of news sources like SEC filings, business publications, and, yes, Twitter, and tell their computer programs to comb through those sources looking for specific words or phrases like “bankruptcy” or “merger” that signal something about the broader market or specific companies.

Why would the stock market crash on news of a bombing? Any attack on a prominent U.S. landmark – particularly the White House – and particularly if the president were injured – would cause tremendous worry of another economic slowdown. If people thought this was something major, they want to sell quickly — you want to be the first one out the door.

If this false story had gone on for a while, how much could the market have crashed? Well, the indexes went down about 1 percent in about two minutes, so it could have crashed fast — but there would have been a bottom. There are also market wide “Circuit Breakers” that will trip if stocks decline excessively during the day. The exact point levels change each quarter, but they represent 10 percent, 20 percent and 30 percent declines in the Dow.

A 10 percent drop in the Dow before 2 p.m. halts trading on the New York Stock Exchange for one hour, for 30 minutes if between 2 p.m. and 2:30 p.m. and have no impact if it’s after 2:30 p.m. A 20 percent drop before 1 p.m. will halt trading for two hours, or for one hour if between 1 p.m. and 2 p.m. If it occurs at 2 p.m. or later, it will be for the remainder of the day. A 30 percent drop will halt trading for the rest of the day, regardless what time it occurs.

In the end however, high-frequency trading isn’t going anywhere, and neither is Twitter.

Fake Tweets can Cause a Stock Market Crash

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