Yesterday’s spooky break down of the markets culminated in some stocks having losses of nearly 100%. The exchanges now try to “correct” this implosion after the matter of fact with a crude rule that cancels all trades with more than 60% movement in a time frame of 20 minutes. They seem to call this ad hoc rule the “Clearly Erroneous Ruling Policy”.
But were these trades clearly erroneous? Most of them were probably caused by stop and market sell orders that didn’t find buying counterparts. From an exchange-technical point of view this is business as usual – nothing erroneous. Viewing it from the flip side, the legal angle, most likely exchanges are completely within the law with their invention of ad hoc policies like this.
But does such a ruling make sense for traders and investors?
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For traders who rely on a stop loss system, a monster drop like this may be demoralizing if they lose their position near the low.
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Aggressive traders using margin may be put out of business. Their broker may liquidate their position at exactly the wrong time. Or they do it themselves with a market order that gets delayed under fast market conditions. Both likely profit from the trade cancellation.
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Investors not knowing about a stop loss are mostly unaffected by temporary crashes like this.
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Those professionals who think they can buy dirt cheap, may find themselves with one leg chopped off if their sale occurred outside of the arbitrary trade busting time frame.
Overall, I think, it indeed makes sense to protect the ordinary trader who tries to prohibit substantial losses with stop sell orders.
For visualization purposes let’s have a look at the weekly chart of URE, a real estate ETF. Yesterday it seems to have crashed by more than 90% in a few minutes before rebounding to a day loss of only 10%. One year ago it got devalued by roughly the same factor 10 during the financial crisis.
Investors would have lost in half a year the same amount as traders in half an hour. But investors do this regularly, because stopping a position is nothing they have in their toolbox.
The conclusion for me is that, while yesterday the traders were worse off than investors, generally it is the other way round. In other words, it still pays off to use the stop loss technique.
Another conclusion may be that many ETFs seem not to have built real trust with regard to inherent value. The market apparently views them more as trading vehicles whose fundamental value is more or less unknown.
And the final conclusion for quoTraders is of course to use a system that concentrates on bigger stocks with real value and promising growth outlook, but doesn’t rely on fundamental analysis while the ship is slowly sinking.
