A splash crash is a stock market event which theoretically could cause significant damage to an economy within a matter of seconds. It would be caused by the prevalence of computers and their programs which are set up to execute trades of various types of securities. These computers can make millions of trades in a just a few moments, which means that they can have a significant impact on the market in a minimum amount of time. Although there are some safeguards in place to prevent the occurrence of a splash crash, many expert investors feel that it is a very real concern in the modern trading world.
The use of technology in the world of investments has increased to the point where just about every major investment firm uses some sort of computer program to make decisions about trades. These computer programs can access limitless amounts of information in a small period of time, thereby proving much more efficient than humans in monitoring various markets for profitable trading opportunities. As a result, computers have been given a great amount of autonomy by their users to make trading decisions, a reality which holds the potential for catastrophic events like a splash crash.
One of the factors that contribute to so-called splash crashes is the interconnectedness of the different markets. Computer trading programs monitor all of the different market sectors, such as stocks, bonds, and commodities, and the way they react to one another. The programs then look for arbitrage opportunities, which is when price discrepancies provide investors a chance to make practically no-risk profits.
Unfortunately, computers react so fast to such opportunities that they can affect the market within seconds. Many computer programs and the complex algorithms they contain can also be tuned into real-world events that affect market supply and demand. When one of these events sends out selling signals to these computer programs, rapid sell-offs can cause a splash crash and a precipitous drop in prices in every market sector.
Many market exchanges have built-in safeguards known as circuit breakers in place to try and stop a potential splash crash. The idea behind a circuit breaker is to automatically shut off trading in certain high-volume securities if their prices drop too far in a short period of time. While these can mitigate the damage of a sudden crash, the sudden drop can still cause a crisis in investor confidence. If human investors follow the lead of the computer programs and sell off their securities in kind, the overall effect on the market can be extremely damaging.