What's Up with Stock Charts on Aug 24th?

Most investors look at charts as an important aspect of their initial investment decisions and of their investment monitoring.  On occasion, you look at a chart and scratch your head, thinking, “What is going on here”.  Such could be the case for some ETFs and stocks on Aug 25.

Reviewing the Equal Weight S&P 500 ETF (RSP), the close of the day was $72.30, marking a new 52-week low at the close.  However, the low of the day was recorded at $43.77, and stands as the official intraday price for most 52-week high and low reporting.  Review RSP charts offered above as a line graph and a point and figure graph to demonstrate this occurrence.

What happened is known as a “Flash Crash”.  A flash crash is a very rapid, deep, and volatile drop in prices occurring within an extremely short time period. A flash crash frequently stems from trades executed by computerized and high-frequency trading. 

On that Monday, in an instant, confusion descended and strange glitches were reported. Stocks fell like rocks, only to shoot back up minutes later. Exchanges spit out the wrong prices for widely held funds.  Some brokerage firms reported slow trading for its online customers.  Trading circuit breakers, or forced time-outs, were triggered at a rate 100 times more often than normal. The Washington Post described it as: “Popular stocks and ETFs bounced like rapid yo-yos.” 

       General Electric (GE) dropped 8% in seconds and then recovered just as quickly.
·        Vanguard Consumer Staples ETF (VDC) was briefly down 32 percent.
·        The iShares Select Dividend ETF (DVY) fell a similar amount.
·        In 15 minutes, the SPDR S&P Dividend ETF (SDY) dropped 33 percent, recovering within half an hour.
·        NASDAQ 100 ETF (QQQ) collapsed 17%, and along with others, recouped most of its losses quickly.

Our beloved Equal Weight S&P 500 (RSP) closed on Fri Aug 21 at $76.39.  The ETF opened on Mon Aug 24 at $71.39 for an initial decline of 6.8%.  Over the course of the flash crash, RSP fell to a low of $43.77 for an eye-popping decline of 38.6% from its open and 42.9% from its Friday close.  RSP closed the day at $73.33 for a daily decline of 4.0%.  

However, the stocks that comprised these ETFs did not decline by a representative amount.  For example, while VDC declined 32% during trading house, the underlying stocks within the ETF did not decline greater than 9%. 

While looking at stock charts and reported 52-week high and low ranges, it is important for investors to realize sometimes these low prices were not reflective of the market on that day and were unavailable to most retail investors like you and me - unless you were selling as a pre-programed stop-loss order. 

Stop-loss or good-til-canceled GTC limit sell orders were trigged by the swift action of their intended computerized precision, but also added fuel to the decline. Both of these order types do not guarantee an execution price but rather triggers a trade at or below the designated price. The execution price can be below the designated stop-loss or limit price if trading continues to fall between the activation price and market execution.   This was the case on Aug 24.    

Retail investors probably lost billions as their pre-programed stop loss orders were executed at what was unsustainable and unrealistic low prices.  Someone was on the other side of the trade, and they were the recipients of the billions lost by retail investors. 

Setting stop losses is a popular strategy to reduce risk exposure if either the premise for buying a stock or ETF proves wrong or in the case of a wide spread market pull back.  However, the computerized nature of these orders puts investors at greater risk in the event of a crash as experienced on Aug 24 – regardless of the reason. 

Similar too many other investing actions, the best use of stop loss and GTC orders is: Know What You Are Doing and Caveat Emptor

This article appeared in the Oct 2015 Issue of Guiding Mast Investments.  Thanks for reading, George Fisher