Months earlier some investors set "stop-loss" orders on stocks they owned. Investors who own a stock selling at $40 today can set a stop-loss order so that the stock is sold automatically when its price falls to $30, perhaps in a month or a year. This way, investors plan to stop losses beyond the $10 that separates $40 from $30. Yet not all investors who placed stop-loss orders understood that a stop-loss order does not guarantee that the stock would be sold at $30. If the price of the stock falls in one swoop from $40 to $20, never pausing at $30, it would be sold for $20. Investors with stop-loss orders might have been on vacation on May 6, 2010, or at the office, but computers traded for them as if they had joined a herd. The selling of stocks pushed their prices down, triggering additional stop-loss sales. In the end, some prices spiraled all the way down to one penny.
The price of Vanguard's Total Stock Market Exchange-Traded Fund (VTI) did not drop to a penny on May 6, 2010, but its decline was large enough to inflict substantial losses on Gary Pinder. Pinder bought the fund in March 2009 and set a stop-loss order on it, which he revised from time to time. On May 5, he set the stop-loss price at $49.17. Yet VTI's stock never paused at $49.17 on May 6. Instead, it paused at $41.15 long enough to let a computer program sell Pinder's stock. Then VTI rebounded to $57.71, leaving Pinder behind.
Ironically, Pinder set his stop-loss "to take the emotion out of selling." Fearing that he might join a human herd, he instead joined a herd of computers. "When I first started working, I hoped to have the option to retire by age 50," says Pinder. "The bursting of the dot-com bubble probably put us back to 55. The 2008-2009 crash put us back to age 60 or so. And now we'll maybe have to work an extra year, or just live with less money whenever we do retire."
A selling wave of futures followed by a selling wave of stocks also marked the crash of 1987. That crash, like the flash crash, renewed debates about the need for "circuit breakers" to halt herds when prices move outside bounds. Following the crash of 1987, the Market Volatility and Investor Confidence Panel recommended that circuit breakers be installed to interrupt trading when prices move outside bounds. The panel's reasons for circuit breakers were grounded in the need to protect us from our cognitive errors and emotions. Circuit breakers provide a time-out to investors amid frenetic trading to pause, evaluate, inhibit panic and restore confidence. And circuit breakers counter the illusion of liquidity by making it clear to investors that markets cannot be relied on to always absorb waves of buying or selling by herds of humans or computers with little change in prices. It turned out that a lesson taught in 1987 had to be learned again in 2010.