Will Flash Crash Trades Stand?

Without knowing what had caused the 20-minute stock-market free fall on May 6, regulators and exchange officials knew it wasn't kosher. Blue chips morphed into penny stocks in the blink of an eye -- and then bounced back. Clearly, no one who could have sold Accenture (symbol ACN) at $40 a share at 2:45 p.m. and at $41 just minutes later meant to sell at a penny in between those times.

In short order, stock exchanges canceled thousands of trades in hundreds of stocks -- any trade between 2:40 p.m. and 3 p.m. that deviated more than 60% from the share price at the start of the rout. Two-thirds of the issues with questionable prices were exchange-traded funds and notes, including Vanguard Total Stock Market (VTI).

Investors spared a 60% loss are relieved. But those whose losses didn't meet the cancellation threshold are frustrated, and bargain hunters denied a windfall are seething. Investors cannot appeal the cancellations, coordinated among several exchanges. Expect a systemwide take on what trades will be deemed "erroneous" in future debacles.

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Allegations of malfeasance or negligence on the part of an exchange will face an uphill battle, says finance professor James Angel, of Georgetown University. And don't blame the broker for a market order executed at the best price at the time of the trade. Exchanges will likely develop a coordinated system of stock-by-stock trading halts to address future disruptions, but the best protection for investors is to use limit orders. Like market orders, they tell a broker to seek the best available price, but they let you set a limit on how much you'll pay or how little you'll accept. Use limits on stop-loss orders, too.

Anne Kates Smith brings Wall Street to Main Street, with decades of experience covering investments and personal finance for real people trying to navigate fast-changing markets, preserve financial security or plan for the future. She oversees the magazine's investing coverage, authors Kiplinger’s biannual stock-market outlooks and writes the "Your Mind and Your Money" column, a take on behavioral finance and how investors can get out of their own way. Smith began her journalism career as a writer and columnist for USA Today. Prior to joining Kiplinger, she was a senior editor at U.S. News & World Report and a contributing columnist for TheStreet. Smith is a graduate of St. John's College in Annapolis, Md., the third-oldest college in America.