Market meltdown May 06, 2010.

The market meltdown sure caused a flurry of activity the past ten days. Lots of ideas about how it happened floated about. The idea that trades would be cancelled interested me when it was announced, and I doubted anything would or could be done. It would be an imposing task and the longer the delay the more difficult the task. Imagine following a 10,000 share trade. Within hours it could trade a number of times. Within a day, and then it stretched to two days, then longer, those shares could be impossible to find. While you are looking they could trade more times than you could find. Without halting the trading, you are falling behind. Now consider another problem. This 10,000 trade could sell in pieces. 5,000 to one trader, 2,000 to another, and 3,000 to a third party. Next thing you know that 5,000 is broken up again as well as the others getting broken up. I’m not saying it would be impossible, but very improbable, unless trading was halted while it got sorted out. If they had ever done that a third world war would have broken out. So I didn’t think that would happen. I also didn’t think they would find the cause. However, they may have come close.

Yesterday I noticed an article on Yahoo, " mystery trader in market meltdown revealed ". This morning I decided to read it…….

By Herbert Lash and Jonathan Spicer

NEW YORK (Reuters) - A big mystery seller of futures contracts during the market meltdown last week was not a hedge fund or a high-frequency trader as many have suspected, but money manager Waddell & Reed Financial Inc, according to a document obtained by Reuters.

Waddell on May 6 sold a large order of e-mini contracts during a 20-minute span in which U.S. equities markets plunged, briefly wiping out nearly $1 trillion in market capital, the internal document from Chicago Mercantile Exchange parent CME Group Inc said.

The e-minis are one of the most liquid futures contracts in the world, providing holders exposure to the benchmark Standard & Poor's 500 Index. The contracts can act as a directional indicator for the underlying stock index.

Regulators and exchange officials quickly focused on Waddell's sale of 75,000 e-mini contracts, which the document said "superficially appeared to be anomalous activity."

More than a week after the incident, it was still not clear what impact the unusual trading in the futures contracts had on the broader meltdown in the stock market.

This was just part of the article. I then read more about Waddell and Reed. They do hedging like most financial companies do, but they are not a hedge fund nor a high-frequency trader.

Next I wanted to understand this " e-mini " product they traded. It turns out to be a small futures contract, one-fifth the size of the normal futures trade. This size allows smaller firms and individuals to trade futures to hedge their positions to market movements.

Waddell and Reed have responded………………..

NEW YORK (CNNMoney.com) -- Investment firm Waddell & Reed responded Friday to a media report that it placed a large sell order for certain stock futures that regulators believe may have contributed to last week's brief-but-historic stock market crash.

In what has come to be known as the flash crash, the Dow Jones industrial average plunged 1,000 points -- the biggest intra-day trading drop ever -- on May 6, briefly erasing $1 trillion in market value, before regaining much of the lost ground. While the ultimate cause of the collapse remains unknown, regulators have focused their investigation on a sharp drop in the value of a stock future called the E-mini S&P 500, which investors use to bet on the future performance of stocks in the broad stock index.

Waddell, an asset management and financial planning company based in Overland Park, Kan., sold a large order of E-mini futures contracts during a 20-minute span that corresponded with the plunge, according to a document obtained by Reuters.

In a statement, Waddell said it was one of possibly 250 other investors trading the E-mini futures contract on the day in question. "On May 6, as on many trading days, Waddell & Reed executed several trading strategies, including index futures contracts, as part of the normal operation of our flexible portfolio funds," the firm said in a statement.

Waddell added that such trades are used to protect investors from potential losses, adding that the firm is a "'bona fide hedger' and not someone intending to disrupt the markets."

"This is a longstanding and well-monitored practice in certain of our investment portfolios," said Waddell.

So what’s the cause of this market plunge? As one trader commented………" An order the size of the Waddell contract would be a big trade to execute on a normal day, said a trader whose firm is active in the S&P 500 futures market. About 50,000 contracts are typically traded in an hour, the trader said.

"To get rid of 75,000 contracts, that's a lot of trading even if the market is healthy," the trader said. "But when suddenly the market changes and there's not as many bids there to trade with, 75,000 is going to cause quite a shock to the market. "

Plain and simple, it’s how markets work. You can talk about conspiracies and manipulation all you want. Put in a big sell order when there are few buyers and this will happen every time. How dramatic will depend on the circumstances at the moment. I’m still betting none of the trades done during that 20 minutes will ever be changed.