How To Handle An ETF Flash Crash

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How To Handle An ETF Flash Crash

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Hi, My name is Corey and I‘m with ETF Trading Research, today were

reviewing our recently published article…

How To Handle An ETF Flash Crash

Investors awoke to a major market selloff on the morning of Monday August 24th, 2015. If you were watching the markets you’ll recall all of major stock indices plunging 5% or more as soon as the

market opened.

The Dow crashed more than 1,000 points, the S&P 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.

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.

What Triggered The Market Selloff?

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.

China’s 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.

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.

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.

Needless to say, these aren’t 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.

As a result there wasn’t 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.

Circuit Breakers Stopped A Flash Crash

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.

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.

But on Monday there were around 1,200 halts.

These short timeouts did their job… they prevented a major flash crash. But ETFs

weren’t so lucky…

ETF Flash Crash

The same circuit breakers kicked in on ETFs as well. But some popular ETFs

still plunged much lower than they should have.

The Guggenheim S&P 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.

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.

The Lesson Every ETF Investor Needs To Learn

You never want to want to put yourself in a position of being a forced to sell at the market price. In other words, don’t use

stop losses that sell your open positions at the market price once they are

triggered.

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 won’t perform

as you want or expect them to.

It’s 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.

But you simply can’t 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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