By now you've probably heard of 'digital currency' Ethereum. News media is full of it. More disturbingly, so is my social media – a sure sign it's to be avoided.
Last week Ethereum punters lost thousands of dollars in stop-loss orders and some underwent margin calls as a result of a 'flash crash' which saw the price of Ethereum drop from US$296 to US$13 in a split-second. Due to the nature of the crash, where the price gapped down, punters had their stop-loss orders executed at US$13, minutes before the price rebounded.
Not stopping anything
Such a thing is not unheard of in the stock market either, bringing to light the question of usefulness (or lack) of stop-loss orders.
In 2010 the US stock market including the S&P500, NASDAQ, and Dow Jones Industrial Average plunged 9% within minutes, recovering 36 minutes later. Some stocks fell 100% to $0 before recovering. A similar, smaller decline happened again in 2015.
Which begs the question, why use stop-loss orders?
Such a thing hasn't happened in Australia, yet, but if you're trying to make a quick buck in like Eden Innovations Ltd (ASX: EDE) or MMJ Phytotech Ltd (ASX: MMJ), or trying to protect your capital in Commonwealth Bank of Australia (ASX: CBA) or Qantas Airways Limited (ASX: QAN), these flash crashes raise an additional risk.
Consider three possible scenarios:
- You are stopped out in relatively normal times after a 10% fall. Volume and price are adequate and you lose ~10%.
- You are stopped out in a 'flash crash' or where there is not many buyers. You take whatever price you can get; at least a 10% loss but potentially much more. Being able to hold would see you dodge the bullet entirely.
- You are stopped out in a market crash-style situation, where everybody is clamouring for the doors at once. You have to take whatever price you can get; worse, you are actively contributing to the crash.
Maybe stop-loss orders have a place in certain portfolios (margin loans) or for certain investors, I won't debate that point.
Yet if you are a retail investor aiming to grow wealth over the long term, it's my view that stop-loss orders are not for you. Volatility (share prices moving up and down) is the price of admission and you should never invest money in the market you are likely to need within the next 3-5 years.
The ability to hold your shares and not sell them is one of the biggest advantages you have.
