How To Handle An ETF Flash Crash

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ETF TRADING RESEARCH
How To Handle An ETF Flash Crash
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How To Handle An ETF Flash Crash
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Investors awoke to a major market selloff on the
morning of Monday August 24th, 2015. If you were
watching the markets youll recall all of major
stock indices plunging 5 or more as soon as the
market opened.
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The Dow crashed more than 1,000 points, the SP
500 was down 120 points, and the Nasdaq was down
393 points within a matter of minutes. Needless
to say, this caught many people off guard.
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After all, the US economy has been steadily
improving to the point the Fed is nearing the
first interest rate hike in nearly a decade.
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What Triggered The Market Selloff?
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In a word China. Economic growth is China has
been slowing for years. The boom time of Chinese
exports ended with the 2008 financial crisis.
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Chinas government has attempted to prop up their
growth rate with a series of questionable
actions. They created real estate bubble and a
shadow banking industry.
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They built a stock market bubble with cheap and
easy to get money in margin accounts. The air
began to come out of the stock market bubble in
June. Chinese stocks are 40 below their peak of
just a few months ago.
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There was little doubt that the Chinese
government was buying stocks to try to stem the
tide. Then China devalued their currency in a
surprise about a week before the US markets
selloff.
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Needless to say, these arent normal things for
the government to be doing. All of the crazy
stuff China was doing caused a lot of investors
to believe that another shoe was about to drop.
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As a result there wasnt anyone that wanted to
buy stocks on the morning of August 24th, 2015 as
the market opened. The market rout was on And it
could have been even worse.
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Circuit Breakers Stopped A Flash Crash
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Back in 2010, the US markets had a Flash Crash
the wiped out about 1trillion of market value in
about 30 minutes of trading. After that they put
in circuit breakers that are designed to slow
down dramatic selling.
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These are triggered when stocks jump or fall by a
certain amount in a matter of minutes. In a
normal day there may be a few halts among all of
the stocks traded on US exchanges.
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But on Monday there were around 1,200
halts. These short timeouts did their job they
prevented a major flash crash. But ETFs werent
so lucky
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ETF Flash Crash
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The same circuit breakers kicked in on ETFs as
well. But some popular ETFs still plunged much
lower than they should have.
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The Guggenheim SP 500 Equal Weight RSP is one
of those ETFs it lost 42 of its value in a
flash during the first few minutes of trading
before recovering.
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RSP has more than 10 billion in it. If it can
be hit by an ETF flash crash then any ETF is
susceptible to a flash crash.
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The Lesson Every ETF Investor Needs To Learn
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You never want to want to put yourself in a
position of being a forced to sell at the market
price. In other words, dont use stop losses
that sell your open positions at the market price
once they are triggered.
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Look, markets are imperfect. They always have
been and they always will be. That means that
the stop losses you have set with your broker
wont perform as you want or expect them to.
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Its better to accept this as the way things are
and adjust to it. You can use mental stops or
have your brokers system notify you by text or
email when the value of the ETF drops below a
certain price.
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But you simply cant use real stop losses with
your ETF positions and expect them to perform how
you want them to when it really matters.
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