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Investors Punished by Never Ending Flash Crashes

Tickers in this article: IRDM NDAQ NYX

NEW YORK ( TheStreet) -- On November 29, 2012 shares in a security linked to satellite operator Iridium Communications (IRDMU) rose about 14,000% after set of trades in the $14 stock spiked to roughly $2000 on Nasdaq(NDAQ) .

That obviously flawed stock quote -- along with similar big price swings in NYSE-traded ETF's like the SPDR Barclays Convertible Securities (CWB) and the Direxion Daily Mid Cap Bull (MIDU) , RLJ Lodging Trust (RLJ) , Kraft Foods (KRFT) and Enstar Group (ESGR) -- are among thousands of examples of high frequency traders violating post-Flash Crash regulations, according to Eric Scott Hunsader, the founder of Nanex, a market data provider.

The same destabilizing trading behavior is seen in big name, high volume stocks like Google(GOOG) , when volatility created by unexpected news events moves shares in a Flash Crash-like manner, Hunsader says. He often highlights those trades on Twitter and Nanex's web site .

One culprit is the so-called 'stub quote,' a sort of placeholder trade that can also test the price of a stock without committing money. The problem is stub quotes were banned by the Securities and Exchange Commission after the 2010 "Flash Crash but - according to Hunsader and other stock market watchers - they continue to cause wild stock swings.

According to the SEC's definition, a stub quote is "an offer to buy or sell a stock at a price so far away from the prevailing market that it is not intended to be executed, such as an order to buy at a penny or an offer to sell at $100,000."

In the past, the practice stub quotes was considered an innocuous way for market makers to maintain quotes in stocks they didn't want to trade. However, in the wake of the Flash Crash, stub quotes were highlighted by SEC chair Mary Schapiro as a key culprit of the day's trading volatility - for instance Apple's(AAPL) surge to roughly $100,000 a share and trades in Boston Beer Company (SAM) and Accenture(ACN) as low as a cent. Recent allegations of market manipulation indicate stub quotes and trade cancellations are part of illegal strategies such as 'spoofing' and 'layering.'

In the Flash Crash, exchanges excluding the NYSE were forced to cancel thousands of trades at prices deemed erroneous when a lack of real bid and ask offers caused stub quotes to be executed. The prohibition now forces market makers to hold bid and ask offers no further than 8% away from the best reported price of a stock, and no more than 20% away at the market's open and close.

While the stub quote may seem like just more Wall Street inside baseball, they can end up hurting retail investors. Some trades stood in the Flash Crash and in similar instances since, causing real investor losses . The crash is also seen as eroding investor confidence and causing chronic outflows from stock markets.