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The 5 Dumbest Things on Wall Street: Oct. 1

2. Investors Still in the Dark on Flash Crashes

There's been a lot of talk about "fat fingers" this year, what with all the mysterious flash crashes bedeviling the best minds of the markets. This week, after the latest flash crash hit shares of Progress Energy (PGN), investors may have reached the point where the only fat finger they're thinking about is their own middle finger, being raised in the face of the SEC and the exchanges.

There were actually two mysterious news items this week about Progress Energy. On Monday, more than 4,000 Progress Energy customers were left without power after a snake slithered into a switch and shorted the circuitry. In the curious case of the snake and the circuitry, Progress Energy restored service in about two hours.

Investors, on the other hand, are still left in the dark about the latest flash crash, when shares of Progress Energy slid from $44.50 to $4.57 in a millisecond early Monday afternoon, making the company's stock chart look like a Robert Downey Jr. EKG printout during a night of partying.

These days, the slithering is coming from the exchanges and market regulators. There was much fanfare about the new circuit breakers after the events of May 6, yet the Progress Energy "mini-flash crash" shows that it's the markets breaking down and the circuit breakers still malfunctioning. Even the Securities and Exchange Commission's preliminary report on the May 6 flash crash, released on Friday, offered few assurances that anybody knows exactly what happened.

According to the SEC, the whole thing may have been caused by a single trade. Apparently, a single trader, reportedly from Waddell & Reed Financial (WDR), entered orders only to sell e-mini S&P 500 futures. The trader had a short futures position that represented on average 9% of the volume traded during that period. The trader sold on the way down and continued to do so even as the price level recovered. Still, that's only being cited as a possible cause.

It's not too much of a stretch to make this analogy: many people are afraid to fly, but few are afraid to fly because they doubt the control mechanisms of the air traffic control system. Many investors have their doubts about the latest biotech stock, but few are afraid to invest as a rule because they don't trust the markets to function effectively. Well, that's not the case anymore with the latest flash crash in shares of Progress Energy.

"I think it has reached the point where the public is so fed up that something has to be done," said Eric Hunsader of market research firm Nanex, who has become a go-to guru in the science of detecting suspicious trading patterns in the era of high frequency trading. "There's no doubt that manipulation is going on to an extent far greater than I've expected, and the exchanges need to dismiss it outright because any exchange that puts out enforcement loses that business to other exchanges," Hunsader said.

Of course, the talking points from the markets about high frequency trading is that it's made for a more efficient market -- except, of course, when the flash crashes are cratering shares, and exchanges like Nasdaq are having to decide on arbitrary trade-cancel policies. In the case of Progress Energy, it was any trade 15% below the National Best Bid and Offer (NBBO). Why 15%? Because Nasdaq decided on 15%. There is no formal exchange policy on what to do when trades need to be canceled because of a flash crash, and that's just one minor frustrating wrinkle in the growing market dysfunction.

For better or worse, the markets are electronic. Machine has conquered man, the battle's over, end of story. But that's not the issue. The average investor has already been forced to wave the white flag when it comes to a man on the trading floor versus an unthinking machine running algos. The problem is some investors are getting ready to wave the white flag about investing in general.

If Joe The Investor could just get a decent quote, the whole man versus machine thing wouldn't be a problem.

TheStreet Says: If you're an investor, get ready to use your fat middle finger when the stock drops from $100 to $1 in a millisecond, while the regulators and exchanges twiddle their thumbs.

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