“Be fearful when others are greedy and greedy when others are fearful” says Warren Buffett. At the opening of the stock market last Monday on August 24, 2015, we saw a ton of fear. Following Buffett’s advice, I got greedy.
Out of sheer luck I happened to be sitting in front of the computer at the opening bell. I was looking at my index fund tracker at Yahoo Finance when I saw one of my recent purchases plummet over 30% for no reason at all. Sure, the entire market was down 5-6%, but that didn’t explain the drastic drop I saw. Then I checked a few other ETFs in my portfolio and noticed they were also down by ridiculous amounts of 30% or more.
After scratching my head for a few minutes, I realized what a galactic treat the cosmos just dropped in my lap. Index fund ETFs at 25% off their intrinsic value! Guns ablazin’, I fired off two trades in my Fidelity account as quickly as I could. I placed an order to buy 100 shares of IJS (iShares Small Cap Value ETF) at $82 and another order to buy 100 shares of IUSV (iShares Large Cap Core ETF) at $92.
The $82 purchase of IJS didn’t execute immediately even though the price was quoted in real time below $82. Strange.
I checked the IUSV order and realized the price shot up to $100 or so with a bid price of $98 and an ask of $101. I immediately replaced my $92 buy order with a buy order at $102. Yes, a buck above the best asking price which should guarantee immediate execution. It didn’t.
Oh crap, I can’t access my order screen at Fidelity! Then began an intense waiting game hoping that my trades were actually in Fidelity’s system and that those trades would be executed before the price recovered beyond my limit prices. Tick tock tick tock.
After what felt like hours but was probably no more than ten or fifteen minutes (just about the right amount of time to go cook a bowl of oatmeal), the order screen at Fidelity came back to life.
First the IJS trade confirmation appeared. 100 shares bought at $82 per share. Then the IUSV trade confirmation appeared. I was the proud new owner of 100 shares of IUSV at $100.85 per share (right at the asking price when I submitted my order and more than $1 below my bid price). Ca-ching!
While I enjoyed the glutinous texture of my slow-cooked oatmeal, I sated my gluttonous appetite for wealth with a nearly instant profit of almost $5,000. I refreshed the quotes on IJS and IUSV a few times and watched them climb up, up, and up just as swiftly and linearly as they dropped thirty minutes earlier.
And that is how I spent the Mini Flash Crash of 2015. Eating a $0.10 bowl of oatmeal (the bulk, slow cooked kind with added cinnamon, raisins, and brown sugar) and making $5,000 from a few well timed trades.
What caused the Mini Flash Crash of 2015?
During the first 30 minutes after the opening bell I noticed a lot of weird stuff going on. The bid/ask spreads on the ETFs I followed went bananas. At times, there was a $20 or $30 spread between the bid price (what buyers are willing to pay) and the ask price (what sellers ask for the shares they want to sell). Typically bid/ask spreads are no more than a few pennies in heavily traded ETFs and perhaps $0.20-0.30 in thinly traded ETFs. Something was definitely wrong.
Being the generous but greedy person that I am, I stepped in to narrow those bid/ask spreads and provide a little liquidity to the market.
But what caused the insanity of the Mini Flash Crash?
- market makers stepped away from the market due to risk
- HFT and algo traders walked away, also due to risk
- Arbitrage traders that swap back and forth between owning an ETF and the basket of stocks within the ETF (that’s why they’re called arbitrage) abandoned the market, too.
The arbitrage guys couldn’t get quotes on the basket of stocks owned within the ETF since some stocks didn’t open for trading for 30 minutes or more. Without stock quotes across the market, the arbitrageurs couldn’t mathematically determine the Net Asset Value (NAV) of the ETF and therefore they couldn’t stomach the risk of buying the ETF and selling the basket of stocks within at unknown prices. The arbitrageurs walked away, too.
In general terms, take away all of the huge market participants and you get severely limited liquidity and horrible bid/ask spreads.
For a more in depth read, check out ETF.com’s commentary on the Mini Flash Crash of 2015.
Even financial advisers get bungled up in temporary market craziness like last Monday’s Mini Flash Crash. From the Wall Street Journal:
Lansing, Mich.-based financial adviser Theodore Feight had set up an automatic sale [a.k.a. a stop loss order] for iShares Core U.S. Value ETF [IUSV] if it were to fall a certain amount. The ETF tumbled 34% in early trading, and instead of Mr. Feight’s position selling at his target price of $108.69, down 14%, it sold at $87.32, off 31%. By noon, the ETF had bounced back, and it ended the day down 4.3% at $121.18.
“I’m really disappointed,” said Mr. Feight, who invested in ETFs for more than a decade. “They weren’t as liquid as they should have been.”
Ouch. Mr. Feight used a stop loss order hoping it would limit losses in his IUSV position. Instead, when the stop loss target of $108.69 was reached on the plunge down, it became a market order, ready for execution at any price. The next price available in the market was $87.32, a full 20% lower than his stop loss target price. A market beset with a lack of liquidity and frozen by intermittent circuit breakers does not mix well with stop loss orders.
Moral of the story: don’t use stop loss orders unless you really really want to sell at any cost and you really really don’t care how much you lose. Limit orders would have prevented the presumably unintended sale of Mr. Feight’s IUSV shares at 31% below the previous closing value. Mr. Feight didn’t respond to the questions I asked him by email four days ago, so I can only make assumptions about his intentions at this point.
Stop loss orders are dangerous because they do not come with a limit on the sale price. They are essentially market orders that get executed once a security drops to a certain target. Save yourself from a big mistake and don’t use stop loss orders or market orders.
Stick with limit orders. It’ll guarantee future market weirdness won’t snatch your shares at an unconscionable price. If you absolutely have to sell something, set the limit price low enough to guarantee it’ll execute (somewhere just below the current bid price) and you should get the same price as a market order coupled with the security of a minimum price limit.
Same advice on the buy side of a trade. If you really really really have to buy something, set the limit price a bit above the current ask price (as I did with the IUSV trade with limit at $102 when the ask was around $101). You won’t get stuck with a wonky trade if the market moves wildly before your trade is executed.
Some other routine trading advice bears mentioning. If you’re buying or selling ETFs and want a decent price without a lot of uncertainty in the markets, avoid the first 30 minutes and the last 30 minutes of the trading day. Those time periods are typically the most volatile and wild price swings right at the open or close can be problematic if you aren’t really careful with limit order prices.
The future of the market
It also bears mentioning that the opportunities I found last Monday rarely present themselves. The markets have traded with decent liquidity since the last Flash Crash five years ago. That’s over 8,000 hours of highly reliable market operations punctuated by a half hour of a big chunk of the market temporarily falling apart. In percentage terms, the market functioned properly 99.994% of the time since the 2010 Flash Crash.
99.994% is so close to perfect that it doesn’t bother me the slightest to continue owning ETF’s and occasionally placing limit orders in the stock market when I need to invest new money, raise cash for living expenses, or rebalance my portfolio to my target asset allocation.
Some critics say the HFT’s, algo traders, opportunist arbitrageurs, and the faceless boogeymen of hi tech capitalism have ruined the integrity of the stock market forever. Except they haven’t. 99.994% of the time they provide liquidity to the markets, improve bid/ask spreads, and make it easier to complete trades in the market by serving as a willing counterparty.
Where were you during the Great Mini Flash Crash of 2015? Did you snap up any winners?
photo credit: Stock Market Crash by zemistor at flickr under creative commons license BY-ND 2.0
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