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What is a Flash Crash?
What is a flash crash?
Flash crashes tend to last a couple of minutes.
In short, the price nosedives and recovers quickly.
That’s a flash crash.
Most traders often confuse flash crashes as crashes. Or worst, when flash crashes come alone, most traders think that something worse – and more permanent – is near.
But there have been lots of forex, stock market and cryptocurrency flash crashes in recent years and none lead to a major crash. That said, if you’re on the wrong side of them or don’t know how to trade them, it can be a career–ending event in the forex markets.
But if you know what a flash crash looks like, then you have nothing to worry about.
What is a flash crash: Three major causes
To start, I believe the number one reason of flash crashes is algorithmic trading. That is computer–based trading using programs.
Here are three common causes of algorithmic trading flash crashes:
- The fat finger
When a trading system gives a buy or sell signal, sometimes the head trader executes the trade. Ever clicked on a wrong key when typing? This is called a ‘fat finger’ event in trading. Let’s say, instead of buying only a million shares, a trader buys 10 million shares. That’s a huge difference and can materially impact the price!
In the past, ‘fat finger’ errors have resulted in multiple massive orders, which are accidentally processed. Although, while they made more of an impact five or so years ago, they aren’t as severe nowadays. Programmers have coded safety measures into the trading system now.
2. High frequency trading
High frequency trading (HFT) errors are increasing these days. They have become more common in forex. HFT uses computers to run strategies that process multiple trades in seconds. Consequently, there’s a risk that a small selloff can turn into a larger flash crash.
3. Software glitches
When trading with software, there can be glitches in the system that cause prices to plunge. Data that’s corrupted can cause glitches, as well as flash crashes, when trading in high frequencies. In the past, this has happened with multiple automatic systems that trade.
The flash crash of 2010
The first major flash crash happened on 6 May, 2010. That’s when the Dow Jones nosedived 1,000 points in a matter of seconds. More than a trillion dollars was initially erased from the market. But most of the losses were recovered by the end of the day.
Market flash crash of 2015
The S&P 500 opened like normal on August 24, 2015. But things soon changed. Within 15 minutes, it had crashed about 5%.
A staggering number.
Again, similar to most flash crashes, most of the losses were recuperated that session. Prices finished 3.6% lower that day.
Why did the 2015 flash crash happen?
Before markets in the US opened on Monday, the Chinese Shanghai Composite lost 8.5%. Traders were worried this would cause the next crash and became bearish. After the US open, many traders cancelled their buy orders and the market started to crash.
Ethereum is the second most popular cryptocurrency in the world. Surprisingly, it had a flash crash back in 2017.
The price flash crashed about $200 in a matter of minutes. That’s a 66% flash crash!
After an investigation into the flash crash, it was found that a multimillion–dollar sell order triggered thousands of stop loss orders. When prices recovered, traders trading on margin were wiped out because prices rose even faster than they fell.
The flash crash of 2018
The Dow Jones flash crashed about 1,600 points in February 2018. The day ended down 1,179 points. At the time, this was the greatest point loss in a single session in Dow Jones’ history. Surprisingly, while it was one of the greatest point declines in history, the flash crash didn’t even make the top 100 percentage-based daily falls.
The market was on fire.
It kept on making record highs leading up to the crash.
Many traders were sceptical about the advance. No market can keep on going up ― or down ― forever. So it wasn’t a surprise it would go down.
But no one ever expects a flash crash!
Aussie dollar 2019
Both the Aussie dollar and Japanese yen had flash crashes in January 2019. The Aussie dipped over 3% against the yen while the yen fall 4% against the US dollar.
These numbers don’t sound like much.
But it was a blood bath.
A 1-2% move is considered huge!
Prices soon spiked and most losses were recovered during the day.
Your ‘Start With Forex’ takeaway: What is a Flash Crash?
Of course, there are more examples of market flash crashes.
We know now that most of the move occurs within a few minutes. But few talk about the true recovery ― it can take a couple of hours. Put differently, while a market might flash crash by 5%, it will often take traders a couple of hours to work out what went wrong.
Flash crashes therefore create buying opportunities.
If you see the next flash crash in action, don’t be afraid to buy the recovery. Flash crashes tend to bounce back by more than 60%. More importantly, as flash crashes can occur at any time, always use a stop loss when trading.
Don’t let a small loss turn into something much larger.
You know what a flash crash is now. Flash crashes have never led to major crashes in the past. That said, it’s important to learn how to recognise major crashes so you can trade them. Forex traders and elite traders, in general, tend to make most of their profits trading major crashes.
If you’re ready to learn how to make millions trading my next stock market crash prediction, click here.
To your trading success,
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