The 1,000 point drop (better) explained

[Kurt_and_Hunter]

A good metaphor to start with is a tsunami. At sea a tsunami looks just a modest hump of water moving along at a good clip through deep water. As it approaches shore the water becomes shallow and the same size mass of water has to fit in a lot less area and it's an explosive event, with the wave rising to seventy or a hundred feet.

For some reason --fat-fingers, software bug or whatever-- some stocks started showing hard-to-believe price action simultaneously. It really doesn't matter whether it was a careless Citi trader or Mrs. O'Leary's cow. The key is that whatever it was, it caused the next step that was the real cause of the crisis: The New York Stock Exchange said, "That looks like a computer error or something..." and they stopped electronic trading, reverting to the slow old-style manual market-maker set-up.

Back in the day that would have worked fine.

But today electronic orders on the NYSE can be filled on a lot of electronic exchanges. Notably NASDAQ, but also London and a bunch of other markets.

Those other venues do not, however, have a fraction of the volume in NYSE stocks that the NYSE does. They are shallow. An imbalance of buy/sell interest that would normally drop stock X a dollar is magnified.

Your order to sell a million shares of stock X is suddenly cut off from electronic NYSE orders to buy stock X. And nobody in the other electronic markets happens to want a million shares of stock X. If they wanted a million shares of stock X they would place their order through the NYSE market-maker in stock X. But he is suddenly out of the picture. So without any buyers the price drops straight down.

(Electronic buy orders were also shunted to low volume markets but the market was dropping sharply at the time so the action was unbalanced. The average order was a sell and the magnification was to the down-side. If the trades shunted into thin markets were mostly buy orders we might have seen a startling spike.)

The NYSE watched the DOW drop 600 points in a minute (D'oh!) and realized that their idea of suspending electronic trading wasn't as smart as it had seemed and resumed electronic trading. Suddenly there was a high volume of available buyers and sellers and prices zoomed up almost as fast as they had fallen.

In tsunami terms, the wave goes back out to sea and drops from seventy feet back down to three feet but contains the same amount of water. Stocks were way down yesterday on merit. The market is over-priced, the European situation is FUBAR. This electronic issue did not cause yesterday's down closing. It did, however, cause about half of the brief 1,000 point drop.