Flash Crashes

[Blitzjoker]

I am a trader of modest means learning the ropes. I day trade at the moment with trivial amounts of money on the Dow Jones Index, and always have a stop loss (not guaranteed), usually around 100 points.

My question is, if there were another flash crash (say 5000 points) that happened more or less instantly, would I be hit for a 5000 point loss by my broker? Or would I be hit with a loss of somewhere between 100 and 5000 points at the broker's discretion? Or is the likelihood of such an event so low, that it is not worth considering?

This may sound a foolish question, but it seems a relevant one to me. For example, I may be safer using an automated system under my own control to manage stops (as I do for trailing stops) rather than rely on a hard stop declared within the trade.

 

[AbbotAle]

It's not worth worrying about for many reasons, including -

1. It hardly ever happens, like lightning striking you

2. There are 3 positions in the market, long, short and flat, probabilities suggest you'll either be short or flat

3. But if you are long, a flash crash doesn't just crash off the highs, the market will ALWAYS be weak, if not critically so, before the real dump. Hence, it's highly unlikely that you'll be long, assuming of course you're not a nutcase trader . But if you were long, 99% chance you'd be stopped out well before the worst of the dump (if using a 100 tick stop).

As for your question, doesn't matter who puts the stop in as long as it's in. That's the only thing you need to do.

 

[AbbotAle]

Also look at the Swiss debacle around 5 years ago. Look at the chart, it had been weak for months so NO trader should have been long.

The Swiss chart is EXACTLY what you'd expect before a flash crash happened. True, it might not have, the peg might have been defended but that still doesn't mean any trader should have been long.

 

[lindq]

I am a trader of modest means learning the ropes. I day trade at the moment with trivial amounts of money on the Dow Jones Index, and always have a stop loss (not guaranteed), usually around 100 points.

My question is, if there were another flash crash (say 5000 points) that happened more or less instantly, would I be hit for a 5000 point loss by my broker? Or would I be hit with a loss of somewhere between 100 and 5000 points at the broker's discretion? Or is the likelihood of such an event so low, that it is not worth considering?

This may sound a foolish question, but it seems a relevant one to me. For example, I may be safer using an automated system under my own control to manage stops (as I do for trailing stops) rather than rely on a hard stop declared within the trade.

Your loss is your loss. What does it have to do with the broker?

And one thing I have found over the years is that if you can imagine a scenario, then you are likely, at some point, to face it.

In setting stops, one is always faced with the decision of protecting against catastrophe, or setting at a more reasonable level, understanding that this may result in more stops being hit.

Back testing can give you some guidance, but short of that you are just in a guessing game. Which is never a good place to be.

Good luck.

 

[Blitzjoker]

Thanks for the replies so far.

AbbotAle if indeed the market is weak before a flash crash, in all likelihood I would be flat or short as you say so that is reassuring. Looking back at some of the crashes that have happened that does seem to be the case, but I have no experience of one myself, and just wondered whether some of the old hands here might have. It sounded to me reading a little about them as if a flash crash could come out of a clear blue sky, but perhaps that is not the case.

lindq "Your loss is your loss. What does it have to do with the broker?"

Perhaps my query is a more general one, in that in theory a market order would be filled at the best available price, but what would that price be if the market fell substantially in an instant, rather than over even a few seconds? Perhaps that never happens, but I could envisage a possibility where you have a stop at 100 pt that gets triggered but not filled before you have a much more substantial loss, whereas if there were no stop in place, the market might simply recover in a few minutes so there would be no loss at all. I don't mind (too much) a 100 pt loss, but a much larger one might be problematic.

 

[Snuskpelle]

You can't trust stops. And at some point you're going to see a major stop blown. Effects depending on parameters can range from something you just shrug off (because you're confident in your strategy), to depression, to career ending.

Only remedies:

• Position size so you can lose 100% long side in a stock or 100 to 10000% short side (depending on type of stock), or about 20% instantly in an index. (Probably requires multiple uncorrelated positions for meaningful profit.)
• Hedge with options. Probably best option when you're trading single positions.
• Pay for guaranteed stops (if your platform supports that in a good way).

FWIW I was short when Fed decided to announce their biggest interventions in the COVID panic earlier this year... took a $6k loss on $80k account instantly despite nominal risk for trade being at 1% of account. Yeah, probably shouldn't have been short at that point, but that's besides the point.

 

[AbbotAle]

Snukes, the trouble with hedging with options or paying for guaranteed stops (only available for spread bets) is the cost.

If options/guaranteed stops are viewed as insurance then insurance doesn't pay out that much because the majority of the time it's not needed (think house insurance). Therefore it's better to self-insure, ie take a few ticks from every profitable trade and use that fund to pay out to yourself if/when you get massive slippage.

PS. There's a reason why guaranteed stops were introduced and it's not to help the clients sleep well at night. Who's selling them and how much do you think they take in versus payout? Plus, they're an excellent marketing gimmick, scare the clients with the tale of horrendous potential losses and just happen to have a product on hand to protect them (for a fee of course)! Fear sells...

 

[AbbotAle]

Thanks for the replies so far.

AbbotAle if indeed the market is weak before a flash crash, in all likelihood I would be flat or short as you say so that is reassuring. Looking back at some of the crashes that have happened that does seem to be the case, but I have no experience of one myself, and just wondered whether some of the old hands here might have. It sounded to me reading a little about them as if a flash crash could come out of a clear blue sky, but perhaps that is not the case.

Yep, 99% of the time the market will always be very weak before a flash crash. Same in reverse as well, look at a stock that really explodes higher, the price will have been moving higher before the massive ramp. It won't just explode from the lows assuming no takeover bid etc.

This is why studying financial history is so important, to get a feel what has happened in the past and the type of moves etc. This was the mistake all the longs in the Swiss made. If they'd known their financial history they never would have traded the Swiss long or short. Plenty of other currencies or markets to trade.

 

[AbbotAle]

OK, it's not a flash crash or a flash upside move but the following is similar to what I've been saying - the vast majority of the time a big sudden move takes a) time to develop, and b) will always be in the direction of the recent move/trend/price action.

Look at a 1m chart of GBP-USD (use tradingview.com if you don't have the data).

Big dump at 12pm due to the Bank of England anoucement.

The price then makes a bottom, starts to stabilise and then the short term trend/flow changes to positive

And then BOOM, for some reason (possibly news, I don't know) we get an sudden explosion higher in the direction of the recent price action.

If you had been short around those lows, assuming you're a short term trader (in and out) there's NO way you'd have been short in that move because you would have been stopped out well before.

 

[Vstk_]

FWIW I was short when Fed decided to announce their biggest interventions in the COVID panic earlier this year

Haha, me too.

"wait, where did I get filled?..."

if indeed the market is weak before a flash crash, in all likelihood I would be flat or short

That is a pretty unrealistic expectation. Most traders don't profit from trading price shocks and outliers.

the market will ALWAYS be weak

Some traders are really good at buying dips, or countertrend scalps, and if it works for them, they should keep doing it.

On the other hand even the best traders make mistakes, it is a good assumption for a beginner that mistakes will be made and that bad luck will happen.
Saying "if you never make stupid trades it won't happen to you" is misleading and wrong. Stupid trades will be made and even good entries can turn really bad because of bad luck.

The best protection against this is, in my opinion, to be very careful with leverage and position sizing. So when you get hit by a market that won't let you out anywhere close to your stop (and if you trade long enough, it will happen), it won't be a disaster.