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Investing

Will Flash Crash Trades Stand?

A formula will decide which transactions stick.

Without knowing what had caused the 20-minute stock-market free fall on May 6, regulators and exchange officials knew it wasn't kosher. Blue chips morphed into penny stocks in the blink of an eye -- and then bounced back. Clearly, no one who could have sold Accenture (symbol ACN) at $40 a share at 2:45 p.m. and at $41 just minutes later meant to sell at a penny in between those times.

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In short order, stock exchanges canceled thousands of trades in hundreds of stocks -- any trade between 2:40 p.m. and 3 p.m. that deviated more than 60% from the share price at the start of the rout. Two-thirds of the issues with questionable prices were exchange-traded funds and notes, including Vanguard Total Stock Market (VTI).

Investors spared a 60% loss are relieved. But those whose losses didn't meet the cancellation threshold are frustrated, and bargain hunters denied a windfall are seething. Investors cannot appeal the cancellations, coordinated among several exchanges. Expect a systemwide take on what trades will be deemed "erroneous" in future debacles.

Allegations of malfeasance or negligence on the part of an exchange will face an uphill battle, says finance professor James Angel, of Georgetown University. And don't blame the broker for a market order executed at the best price at the time of the trade. Exchanges will likely develop a coordinated system of stock-by-stock trading halts to address future disruptions, but the best protection for investors is to use limit orders. Like market orders, they tell a broker to seek the best available price, but they let you set a limit on how much you'll pay or how little you'll accept. Use limits on stop-loss orders, too.

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