The topic of Stop Losses and Flash Crashes is back in the news. On Friday, India’s National Stock Exchange (NSE) experienced a flash crash that took the NIFTY 50 Index down 16% in an instant. Most stocks in the Index experienced crashes of between 15 and 20%. Circuit breakers that were supposed to be triggered at a 10% drop did not work, and they ultimately kicked in after a few minutes when the index had dropped 16%. Markets were halted, systems were reset and when it opened again, the Index recovered most of its losses but ended in the red for the day, but well off its lows. Read the full Bloomberg article here.

1. www.optiontiger.com
Get a 75% EDGE on every Options trade
The perils of Stop Losses
Author: Hari Swaminathan
Do you use Stop Losses
– investors be warned

2. www.optiontiger.com
Founder, www.OptionTiger.com
Trader, Author, Mentor, Entrepreneur
Bachelors in Engineering, India
MBA – Columbia Business School, NYC
Hari Swaminathan

3. www.optiontiger.com
On a morning like today, when the SPX gaps down 17 points by the
time we wake up in the United States, due to any number of
concerns in Europe or Asia, the first thought that may come to an
investors mind is – How is my portfolio going to be affected ? And the
second thought may seem to be comforting if you’ve set up Stop
Losses for your stocks. But this is a false sense of comfort.
I had written an earlier post a few years ago, reflecting on the events
of the infamous “Flash Crash” day and what exactly happened on
that day. That post is replicated here, and provides some deep
insights into how Stop Losses work, and why investors should not take
comfort in Stop Losses. Most importantly, you’ll always hear money
managers tout the use of Stop Losses as some perfect loss prevention
mechanism. In reality, it is anything but. Take a read on what
happened on Flash Crash day and what happened to investors who
had places Stop Loss orders. This post below is from a couple years
ago.
About OptionTiger

4. www.optiontiger.com
The topic of Stop Losses and Flash Crashes is back in the
news. On Friday, India’s National Stock Exchange (NSE)
experienced a flash crash that took the NIFTY 50 Index
down 16% in an instant. Most stocks in the Index
experienced crashes of between 15 and 20%. Circuit
breakers that were supposed to be triggered at a 10%
drop did not work, and they ultimately kicked in after a
few minutes when the index had dropped 16%. Markets
were halted, systems were reset and when it opened
again, the Index recovered most of its losses but ended in
the red for the day, but well off its lows.
Read the full Bloomberg article here.
About OptionTiger
Sound familiar ? This is exactly what happened on May 6, 2010 in the US. The S&P 500
crashed over 10% but recovered most of its losses, all in about 20 minutes time. Just like
the US incident, “fat fingers” typing erroneous Futures orders in the “billions” rather than
the millions are blamed in the Indian incident as well. With one difference – while we still
don’t know what really happened in the US after 2 years, the culprit was identified almost
immediately in India. The broker responsible for the erroneous order (Emkay Global
Financial Services) was immediately sequestered, all their orders closed out, and their
license to operate in the Indian markets was revoked on the same day. Talk about being
judge, jury and meting out swift punishment.

5. www.optiontiger.com
But I want to focus on one very important
issue about Flash Crashes and Stop Losses.
Most investors including institutional
investors use Stop Losses to prevent any
further loss when your stock price drops.
The way this works is you put a Stop Loss
order and leave that order open with a
status of “Good till Cancelled”. This order
remains open in your account until you
explicitly cancel it or until it gets executed.
About OptionTiger
The concept itself makes a lot of sense – if you want to protect your position
beyond a certain point, put your Stop Loss at that point, and you don’t have to
worry about it after that. But is this really the truth ? And what happens when you
have a Flash Crash ? Let’s see what happened in the US in 2010, and what must
have surely happened in India as well on Friday.

6. www.optiontiger.com
To understand what happened, we need to understand the Stop Loss
order in a little bit of detail. When a Stop Loss gets triggered, your order is
automatically converted into a “Market Order”. In a Market Order, your
stock gets sold at whatever price the market is quoting at that particular
point in time, as reflected by the Bid and Ask prices. Herein lies the
problem,and it’s a very big problem. In the middle of a Flash Crash, the Bid
and Ask prices are tumbling instantly and prices are crashing but no orders
are being executed at this time. But your order is a market order, so its
designed to execute whatever price the market allows it to execute. And
in a Flash crash, this execution can happen at a price that is significantly
lower that your Stop Loss point.
About OptionTiger

7. www.optiontiger.com
Lets use an example. You own Google (GOOG) stock. GOOG price is
770, and you (or your money manager) has a Stop Loss order at 700.
If the price of GOOG falls to 700, your Stop Loss order gets converted
into a Market order and your stock will be sold in the market. In an
orderly market, you can expect to sell GOOG at very close to 700,
perhaps 698 or certainly at 695. But in a Flash Crash, the Bid and Ask
prices are tumbling without any executions. So GOOG could go
down to 600 or even 500, and at whatever point the market gets an
opportunity to sell your stock, it will. This is exactly what happened in
the US markets in 2010, and many investors got wiped out because
these Stop-Loss-orders turned into Market orders and sold stock at the
lowest possible point. To add insult to injury, the Flash Crash then
recovers and GOOG makes it all the way back up along with the rest
of the market and may end up at 740 for the day. Still in the red, but
well off its lows. But to your dismay, your position was closed out at
500 only to see the stock bounce back up to 740. If that’s not a Royal
Shaft, I don’t know what is.
About OptionTiger

8. www.optiontiger.com
The sad part is financial advisors and wealth managers tout the use of Stop
Losses as a risk control mechanism. Next time you hear that, ask them how
their Stop Losses worked on May 6, 2010. And if you do use Stop Losses, use a
“Stop Limit Order”. This would work something like this – your GOOG Stop Loss
is at 700, but you also specify a Stop Limit at say 690. This means that your
order will execute only between a price range of 690 to 700. If GOOG falls
below 690, your order will not execute, and you can save yourself a ton of
agony. Read these articles to find out what really happened to investors on
May 6, 2010.
http://seekingalpha.com/article/205009-stop-loss-orders-and-the-flash-crash-a-false-sens
Here’s an attorney who will represent you for losses from Stop Losses during a
Flash Crash.
http://www.crarybuchanan.com/Law-Blog/2012/April/Flash-Crash-and-Stop-Loss-Orders.a
http://online.wsj.com/article/SB10001424052748703950804575242942496526282.html
About OptionTiger

9. www.optiontiger.com
About OptionTiger
FREE MINI-COURSES (Over 40 courses and growing)
WeeklyMAX – Use Weekly Options smartly for income
CondorMAX – Sophisticated intellectual property for Iron Condors
AdjustMAX – Master the art of adjusting any Options position
SwingTradeMAX – A powerful swing trading system using Options
DayTradeMAX – A powerful intraday trading system using Options
IncomeMAX Spreads and Straddles
EarningsMAX – A complete playbook for Earnings reports trades
SwingTradeMAX Subscription – Live Chat room for swing trading

10. www.optiontiger.com
About OptionTiger
DayTradeMAX Subscription – Live Chat room for Day trading
OptionTiger YouTube channel
OptionTiger Udemy channel
OptionTiger Blog of Trading Ideas and Market commentary
FREE WEBINAR REPLAYS

11. www.optiontiger.com
www.OptionTiger.com
info@optiontiger.com
/OptionsTigerTrading
@optiontiger
/OptionTiger
Top 30 Udemy instructor:
www.udemy.com/u/hariswaminathan
Get a 75% EDGE on every Options trade
Thank You!!!