Best of the Week
Most Popular
1. Stock Markets and the History Chart of the End of the World (With Presidential Cycles) - 28th Aug 20
2.Google, Apple, Amazon, Facebook... AI Tech Stocks Buying Levels and Valuations Q3 2020 - 31st Aug 20
3.The Inflation Mega-trend is Going Hyper! - 11th Sep 20
4.Is this the End of Capitalism? - 13th Sep 20
5.What's Driving Gold, Silver and What's Next? - 3rd Sep 20
6.QE4EVER! - 9th Sep 20
7.Gold Price Trend Forecast Analysis - Part1 - 7th Sep 20
8.The Fed May “Cause” The Next Stock Market Crash - 3rd Sep 20
9.Bitcoin Price Crash - You Will be Suprised What Happens Next - 7th Sep 20
10.NVIDIA Stock Price Soars on RTX 3000 Cornering the GPU Market for next 2 years! - 3rd Sep 20
Last 7 days
Global Banking: Some Sectors Look as "Precarious as Ever" - 28th Oct 20
Silver Price Minor Dip Possible Before 2nd Major Upleg Starts - 28th Oct 20
�� How to Carve a Simple and Scary Pumpkin Face for Covid Halloween 2020 �� - 28th Oct 20
Gold Price One Last Dip Likely Then Major Upleg to New Highs - 28th Oct 20
Smart Money Is Going All-In On This New Gold Frontier - 28th Oct 20
Gold Stocks Still Correcting - 27th Oct 20
Gold and Crypto: Is This How Charts Look Before A Monetary Collapse? - 27th Oct 20
Silver's Coming Double Trigger Shotgun Price Explosion - 27th Oct 20
The $126 Billion Gold Opportunity in Australia - 27th Oct 20
Tips to Breeze through Your Spanish Classes Online - 27th Oct 20
Try The “Compounding Capital Gains” Strategy Today - 26th Oct 20
UK Coronavirus Broken Test and Trace System, 5 Days for Covid-19 Results! - 26th Oct 20
How the Coronavirus is Exacerbating Global Inequality, Hunger - 26th Oct 20
The Top Gold Stock for 2021 - 26th Oct 20
Corporate Earnings Season: Here's What Stock Investors Need to Know - 25th Oct 20
�� Halloween 2020 TESCO Supermarkes Shoppers Covid Panic Buying! �� - 25th Oct 20
Three Unstoppable Forces Set to Drive Silver Prices - 25th Oct 20
Car Insurance And Insurance Claims and Options - 25th Oct 20
Best Pressure Washer Review - Karcher K7 Full Control Unboxing - 25th Oct 20
Further Gold Price Pressure as the USDX Is About to Rally - 23rd Oct 20
Nasdaq Retests 11,735 Support - 23rd Oct 20
America’s Political and Financial Institutions Are Broken - 23rd Oct 20
Sayonara U.S.A. - 23rd Oct 20
Economic Contractions Overshadow ASEAN-6 Recovery - 23rd Oct 20
Doji Clusters Show Clear Support Ranges for Stock Market S&P500 Index - 23rd Oct 20
Silver Market - 22nd Oct 20
Goldman Sachs Likes Silver; Trump Wants Even More Stimulus - 22nd Oct 20
Hacking Wall Street to Close the Wealth Gap - 22nd Oct 20
Natural Gas/UNG Stepping GAP Patterns Suggest Pending Upside Breakout - 22nd Oct 20 -
NVIDIA CANCELS RTX 3070 16b RTX 3080 20gb GPU's Due to GDDR6X Memory Supply Issues - 22nd Oct 20
Zafira B Leaking Water Under Car - 22nd Oct 20
The Copper/Gold Ratio Would Change the Macro - 21st Oct 20
Are We Entering Stagflation That Will Boost Gold Price - 21st Oct 20
Crude Oil Price Stalls In Resistance Zone - 21st Oct 20
High-Profile Billionaire Gives Urgent Message to Stock Investors - 21st Oct 20
What's it Like to be a Budgie - Unique in a Cage 4K VR 360 - 21st Oct 20
Auto Trading: A Beginner Guide to Automation in Forex - 21st Oct 20
Gold Price Trend Forecast into 2021, Is Intel Dying?, Can Trump Win 2020? - 20th Oct 20
Gold Asks Where Is The Inflation - 20th Oct 20
Last Chance for this FREE Online Trading Course Worth $129 value - 20th Oct 20
More Short-term Stock Market Weakness Ahead - 20th Oct 20
Dell S3220DGF 32 Inch Curved Gaming Monitor Unboxing and Stand Assembly and Range of Movement - 20th Oct 20
Best Retail POS Software In Australia - 20th Oct 20
From Recession to an Ever-Deeper One - 19th Oct 20
Wales Closes Border With England, Stranded Motorists on Severn Bridge? Covid-19 Police Road Blocks - 19th Oct 20
Commodity Bull Market Cycle Starts with Euro and Dollar Trend Changes - 19th Oct 20
Stock Market Melt-Up Triggered a Short Squeeze In The NASDAQ and a Utilities Breakout - 19th Oct 20
Silver is Like Gold on Steroids - 19th Oct 20
Countdown to Election Mediocrity: Why Gold and Silver Can Protect Your Wealth - 19th Oct 20
“Hypergrowth” Is Spilling Into the Stock Market Like Never Before - 19th Oct 20
Is Oculus Quest 2 Good Upgrade for Samsung Gear VR Users? - 19th Oct 20
Low US Dollar Risky for Gold - 17th Oct 20
US 2020 Election: Are American's ready for Trump 2nd Term Twilight Zone Presidency? - 17th Oct 20
Custom Ryzen 5950x, 5900x, 5800x , RTX 3080, 3070 64gb DDR4 Gaming PC System Build Specs - 17th Oct 20
Gold Jumps above $1,900 Again - 16th Oct 20
US Economic Recovery Is in Need of Some Rescue - 16th Oct 20
Why You Should Focus on Growth Stocks Today - 16th Oct 20
Why Now is BEST Time to Upgrade Your PC System for Years - Ryzen 5000 CPUs, Nvidia RTX 3000 GPU's - 16th Oct 20
Beware of Trump’s October (November?) Election Surprise - 15th Oct 20
Stock Market SPY Retesting Critical Resistance From Fibonacci Price Amplitude Arc - 15th Oct 20
Fed Chairman Begs Congress to Stimulate Beleaguered US Economy - 15th Oct 20
Is Gold Market Going Back Into the 1970s? - 15th Oct 20
Things you Should know before Trade Cryptos - 15th Oct 20
Gold and Silver Price Ready For Another Rally Attempt - 14th Oct 20
Do Low Interest Rates Mean Higher Stocks? Not so Fast… - 14th Oct 20
US Debt Is Going Up but Leaving GDP Behind - 14th Oct 20
Dell S3220DGF 31.5 Inch VA Gaming Monitor Amazon Prime Day Bargain Price! But WIll it Get Delivered? - 14th Oct 20
Karcher K7 Pressure Washer Amazon Prime Day Bargain 51% Discount! - 14th Oct 20
Top Strategies Day Traders Adopt - 14th Oct 20

Market Oracle FREE Newsletter

How to Get Rich Investing in Stocks by Riding the Electron Wave

Flash Stock Market Crash, the Dark Side of Stop Loss Orders

InvestorEducation / Learning to Invest Oct 03, 2010 - 06:06 AM GMT

By: Richard_Shaw

InvestorEducation

Best Financial Markets Analysis ArticleWe are proponents of persistent percentage trailing stop loss orders to protect against significantly declining markets. If more investors used stop loss orders, fewer investors would have been devastated by the the 2008 stock market crash. Just like seat belts and airbags that save lives in auto crashes, stop loss orders save portfolios in market crashes. However, in a small minority of cases, seat belts or airbags are a partial cause of injury in an auto crash. Similarly, in a small minority of cases, stop loss orders are a partial cause of investment losses.


Unfortunately, the frequency of occasions where stop loss orders are part of unintended, loss producing trades may be on the increase. In former times, specialists were charged with maintaining an orderly market by creating supply or demand when needed to smooth price movements. These days electronic trading reigns with some occasional severe price distortions. That's where the dark side of stop loss orders comes into play.

The "flash crash" of May 6th 2010 is an obvious and dramatic example of market chaos that can arise from electronic trading without the smoothing actions of specialists. Some regulations may be changing, but we doubt they will be sufficient anytime soon.

This chart shows the nearly 100 point "instantaneous" drop in the S&P 500 on May 6th. We had millions of dollars in positions in SPY that day and all were stopped out, but fortunately, the price before the stop was already close to the trigger price; and because of the extreme liquidity of SPY, we suffered only a minor loss. Take note that liquidity is key when thinking about stop loss orders. The less the liquidity the greater the danger.

We have a policy of (a) not owning securities with less than 3-month average daily dollar trading volume of $25,000 per minute, and (b) not owning more than 2% of the daily dollar trading volume of a security (preferably less than 1%) -- not a perfect solution, but it helps

This chart is for the Vanguard Total US stock market, a far less liquid security, which also took a deep instantaneous dive on May 6th. We had some, but not much of that ETF at that time. Rather than the lower than 10% dive for SPY, VTI declined nearly 50% in a few seconds.

Many investors with stop losses were partially restored that day by the dealers breaking some of the trades, but not all trades were reversed.

Unfortunately, the problems are not gone, and the non-specialist, electronic trading system can still be a treacherous system. Case in point, LQD today.

Yesterday, September 30, LQD closed as $113.09. At the open today, in the first minute, the low was $101.25 -- over a 10% decline. At the end of the second minute of trading, the low was $111.75 and the high was $112.54.

In the complete absence of major negative news, a diversified portfolio of investment grade corporate bonds has absolutely no fundamental or technical reason to decline by 10% on an overnight basis -- and if it did have reason, then there is no reason to recover the 10% loss in the next one minute. This is a pure and simple example of the failure of the currently constructed electronic trading systems to create and maintain a reasonably orderly market -- and a good example of why so many investors are frightened away. There is an urgent need for some kind of stabilizing, circuit-breaker algorithms per security to be built into the electronic system in the absence of human specialists

To our shock and dismay today, we had LQD positions in several accounts with stop loss trigger prices of approximately $109. Those positions were stopped at 9:31 AM at prices between $101.74 and $101.81. Those were huge losses equal to about 2.5 years of interest and substantially more than the losses that would have occurred with a sudden unexpected 2% interest rate increase.

To our extraordinary relief, Schwab (the broker we use), adjusted those trades. They couldn't reverse them -- we are still stopped, but they were able to establish a "bad print" and adjusted our execution price to levels we found quite satisfactory in the vicinity of the prices that prevailed in the minute after our stop.

So much for our tale of horror, and relief. The issue for you is to be aware of these electronic trading risks and pick the alternative that best suits you.

With some (perhaps many) brokers you have these choices;

  1. do nothing -- buy and hold -- avoid whipsaws, but suffer the damage of the next "2008"
  2. closely monitor price and use mental stops -- immune from electronic distortions, but exposed to emotional instead of rational exit decisions, and need for constant observation (no time off)
  3. use technical stops -- removes emotional decisions, but you've got to be watching all the time (forget two week vacations)
  4. use multiple criteria conditions for stops (e.g. Bid and Ask pierce trigger price) -- but those orders expire and new trailing stops cannot restore old set points
  5. (at Schwab) use non-expiring "bracket" orders when opening a position -- automatic until you cancel order, but only based on Bid which sometimes collapses (as it did for LQD today)

Our problem today, was the we chose #5 for non-expiring protection, but were hit by collapsing Bids. You can bet we raised heck with Schwab suggesting that they should make the multiple conditions options available on bracket orders that they make available on approach #4 -- or, they should make the multiple conditions approach of #4 non-expiring, at least as an option. If you use both the Bid and the Ask as conditions, it is less likely that a instantaneously collapsing Bid would be accompanied by an instantaneously collapsing Ask.

If you have a short-term position (less than 60 day horizon at Schwab or a 120 day horizon at Fidelity to match their expiration times), we strongly recommend method #4. If you have a long-term position, we recommend using very liquid securities and approach #5 (unless you are an accomplished technical trader with option #3).

Keep in mind that stop-loss orders (which are market orders when executed) are not available for mutual funds, options, or individual bonds, but are available for stocks, ETFs, ETNs, CEFs, MLPs, and public royalty trusts. To deal with that problem, we have developed an in-house "stop alert" system that makes an end-of-day evaluation of securities it tracks and emails QVM, as well as the client if they wish, to suggest it is time to exit a position. That is the only practical solution we have for stop loss option #4 after the order expires.

Until Schwab or others implement a multiple conditions option for non-expiring, investors are left with choosing their form of protection from alternatives each with positive and negative attributes.

We hope this article helps brokers more seriously consider the needs of investors for multiple conditions, non-expiring stop loss orders; and helps investors think more comprehensively about the pluses and minuses of different stop loss order approached..

Holdings Disclosure: As of October 1, 2010, we hold SPY and LQD in some managed accounts.

By Richard Shaw 
http://www.qvmgroup.com

Richard Shaw leads the QVM team as President of QVM Group. Richard has extensive investment industry experience including serving on the board of directors of two large investment management companies, including Aberdeen Asset Management (listed London Stock Exchange) and as a charter investor and director of Lending Tree ( download short professional profile ). He provides portfolio design and management services to individual and corporate clients. He also edits the QVM investment blog. His writings are generally republished by SeekingAlpha and Reuters and are linked to sites such as Kiplinger and Yahoo Finance and other sites. He is a 1970 graduate of Dartmouth College.

Copyright 2006-2010 by QVM Group LLC All rights reserved.

Disclaimer: The above is a matter of opinion and is not intended as investment advice. Information and analysis above are derived from sources and utilizing methods believed reliable, but we cannot accept responsibility for any trading losses you may incur as a result of this analysis. Do your own due diligence.

Richard Shaw Archive

© 2005-2019 http://www.MarketOracle.co.uk - The Market Oracle is a FREE Daily Financial Markets Analysis & Forecasting online publication.


Post Comment

Only logged in users are allowed to post comments. Register/ Log in

6 Critical Money Making Rules