Flash Crashes

[TheGoonior2]

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?

Are you using a "stop" order or a "stp-lmt" order? In an actual "flash crash", a stop order could be your worst enemy. These types of crashes are going to be either: 1) Some major disaster after which you've got bigger problems than your portfolio, or 2) (more likely), some short term thing caused by an exchange glitch/hack or rogue trades or whatever.

Take a look at the May 6, 2010 crash. Drop and "V" bounce. Chances are your stop becomes a market order and gets you filled at the worst possible time. If you are lucky, trades get busted, but I wouldn't want to count on it.

If you tend to monitor the market frequently, you might want to set alerts rather than actual orders so you can take the appropriate action manually.

Remember also that there are now circuit breakers in place, so you might want to review those as well.

 

[Vstk_]

If you tend to monitor the market frequently, you might want to set alerts rather than actual orders so you can take the appropriate action manually.

This can backfire pretty badly. With a hard stop order (at the market) you can always decide to get back into the market if you think it is time to play the rebound. But if the market just keeps going and going in a runaway mode you are truly going to be decimated if you don't get out immediately

If you see stops as disaster insurance, it doesn't make sense to use stop limit orders because they fail to address the worst case scenario.

 

[Laissez Faire]

Regular stops are market orders, i.e., executed at market.

This means that if your stop order is triggered, but not executed due to a lack of liquidity, you can effectively end up in debt when the order is finally executed at a far worse price.

One possible solution if this worries you is to hedge with options instead, but not sure it's a practical solution for day trading.

https://jasonzweig.com/when-stop-loss-trades-backfire-on-investors/

Mr. Pinder decided to set a stop loss of 20% below the latest high price of his ETF shares. He updated the stop-loss point whenever the market made a major upward move. On May 5, Mr. Pinder logged on to his account with Charles Schwab and raised his stop-loss on VTI from “the $46 range” to $49.17.

The next day, Thursday, was the flash crash. At exactly 2:48 p.m. EDT, according to Mr. Pinder, his shares fell through the floor. But Mr. Pinder wasn’t “stopped out” at $49.17. Instead, with the market in free fall, his instructions automatically converted to a market order that sold his shares at prices far below his trigger price—at an average of $41.15.

 

[TheGoonior2]

This can backfire pretty badly. With a hard stop order (at the market) you can always decide to get back into the market if you think it is time to play the rebound.

Sure...Assuming you get filled at a reasonable price. Stop orders become market orders when the stop price is hit. Nothing says you get filled at that price. The OP mentions a "near instantaneous" drop of 5000 points. That's a near 20% gap down at current levels. Even 9/11 type events don't cause that. Those type of news events take time to propagate. Do you want a market order sitting out during a flash crash and "V" recovery? For black swan events of that type, a stop order is no protection...you need a hedge in place already

 

[CALLumbus]

Stops will help 99,9% of the time in liquid markets, but every once in a while, you have a sudden shift, a shock in a market, which makes the market change or gap so quickly that there just wont be a market near your placed stop level, there will just be pockets of air and the market gone already, far away. So yes, stops make sense for many traders, in many situations, but they are no 100% guarantee. Always be aware of this, and use other tools to protect your account.

"Tom Baldwin: The reason you can’t is that is really not the market. At 7:29 am before the number comes out the market is at ‘x’ and then when the number comes out and its out of line, the actual market has a gap between where it eventually goes to and where it starts. And in between there is really nothing there because the market is now here. And most people are not accustomed to that jump and they are not aware that there is really nothing to trade there, unless it is by luck. i.e. there was resting order that happened to be there, doesn’t happen often. So you would never get filled at those prices. It would be very easy if when the number came out and you said gee that’s way out of line and it’s really bullish and I want to be long 1000 bonds, well the rest of the world is not stupid either and they see its out of line so they decide not to sell now. When it rallies a point then I’m going to sell it. Because that is where the market should go to based on that number. It’s like saying I wish I could buy 1000 bonds a point below market, but it’s not the market."

https://www.turtletrader.com/borish-baldwin/

 

[CALLumbus]

Sure...Assuming you get filled at a reasonable price. Stop orders become market orders when the stop price is hit. Nothing says you get filled at that price. The OP mentions a "near instantaneous" drop of 5000 points. That's a near 20% gap down at current levels. Even 9/11 type events don't cause that. Those type of news events take time to propagate. Do you want a market order sitting out during a flash crash and "V" recovery? For black swan events of that type, a stop order is no protection...you need a hedge in place already

For many (over)leveraged traders, even a 5% move means "game over", "format C:" and "bring all your current and future cash to your broker".
I have seen a few such sudden moves in the past 15 years.
No stop will help you in those situations. What helps is to not be overleveraged, and/ or to be protected by the product type you trade. Your trading style and experience of course also have a big influence on how good or bad you will get out of that situation.
But I agree, a stop is basically useless in such a situation.

 

[Vstk_]

Sure...Assuming you get filled at a reasonable price. Stop orders become market orders when the stop price is hit. Nothing says you get filled at that price. The OP mentions a "near instantaneous" drop of 5000 points. That's a near 20% gap down at current levels. Even 9/11 type events don't cause that. Those type of news events take time to propagate. Do you want a market order sitting out during a flash crash and "V" recovery? For black swan events of that type, a stop order is no protection...you need a hedge in place already

I might have been unclear but I am taking the risk of horrendous slippage into account.

My point is that if you find yourself in the situation where price is moving sharply against you, you have the choice between :
- exiting your position at the market because you are not in control anymore
- hoping and praying for a V recovery

You do not know at the moment it happens if the sharp and exceptional move is going to reverse anytime soon. Maybe a nuclear bomb went off. Crazy things do happen once in a while, that justify extreme price moves.

If I feel like I have no idea what the hell is going on and my position is being killed at the speed of light, I would rather pay for the massive slippage to be out of the market at once. If you are an investor who has a long time horizon and no leverage, it is different.

 

[ondafringe]

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.

Are you using a "stop" order or a "stp-lmt" order? In an actual "flash crash", a stop order could be your worst enemy. These types of crashes are going to be either: 1) Some major disaster after which you've got bigger problems than your portfolio, or 2) (more likely), some short term thing caused by an exchange glitch/hack or rogue trades or whatever.

With DOW futures, even if he is using a basic Stop, pretty sure the exchange will *automatically* add a Stop-Limit 60 points out beyond his basic Stop.

 

[Blitzjoker]

Thanks for all the comments; they have been very helpful. For the record, I only use stop orders at the moment, not stop limit orders, but I can see that there are dangers to that approach. I guess it is just another risk to be factored in. I have already seen some hefty slippage when the market is moving quickly; I am just trying to quantify a worst case scenario, and how likely it is to happen.

 

[SunTrader]

Always good to prepare in advance, for the worst that could happen, while keeping in mind it happens very rarely.