I've never worked in a brokerage house, but:
The selloff panic only lasted for about 20 minutes. Before then, it was looking like a hard but not all that abnormal selloff considering what the markets have done not too long ago. In the 20 minutes the dow dropped 600 points.
It seems to me, that there wasn't alot of trader conviction in the ability of the markets sustain these levels (11k ish). So once a chain of big stops got hit, it was on. Its anybody's guess how many funds and retail accounts got liquidated on the way down.
The real question is what would've happened if the market closed -1000 for the day. Prime brokerages do not have the same auto-liquidation procedures as retail brokerages. One reason is while you can auto liquidate 50k of GE stock in joe schmoe's account, its hard to liquidate 400M of GE at stock quickly without crashing the stock. It something you can't automate, it generally has to be done manually. In 20 minutes you can only manually liquidate so many margin accounts, and make so many margin calls. Especially when perhaps 50% or more of your clients have overused their margin. I suspect many if not most prime brokers were temporarily insolvent during the crash.
If stocks stayed -1000 for an extended period, say an hour, brokers would've gotten around to liquidating alot more institutional accounts. There was a temporary and severe liquidity shortage due to the collapse in asset values. But in a short time share prices "recovered".
Where did all this money come from to cause the dramatic rebound? Retail traders were out with their stops hit, plus they really aren't fast enough to get in on something like that. Institutional players were facing collapsed asset values precipitating a severe cash crunch and imminent margin calls.
The most likely cause was that a bank(s) stepped in and bought everything. Everybody else was out of cash. The banks are the only ones with deep enough liquidity to match orders into severe market auto liquidation and panic selling. Thats the best explanation I can come up with.
