While you were sleeping in the early hours on Friday 7 October 2016 morning, there was pandemonium in the Forex market.
At around 01:00am, the British pound crashed over 800 pips suddenly.
Some brokers, traders and institutions went bankrupt in a number of seconds. This is known as a “flash crash” or a “fat finger” incident.
And guess what caused the crash?
Today I'm going to show you why they happen and how to avoid these “flash-crashes” from ever wiping out your account.
But first let me explain why I suspect it happened on Friday.
The pound is feeling the symptoms of “BREXITitus”
Lately, the pound has been feeling immense pressure since the Brexit occured. This is where the UK decided to exit out of the European Union.
And because of Brexit, there have been less traders and institutions buying the British pound. And when there’s less volume, there’s lower trading activity which can cause big moves.
We know this because on Friday, the British pound opened the week with a new week low.
So what could have caused this sudden crash?
Well there are speculations saying that, during the early hours of the morning, there was thin liquidity (low traded volume) and big downside pressure.
And when there’s low liquidity, in any market or currency, you can expect a big swing (high volatility).
This low volume crash, would happen when traders or institutions, at the time, failed to load their bid (buy) levels into their trading platforms. And this signalled what’s called an Algo-facilliated-flash-crash.
But also take note of the time that the flash-crash happened.
The crash happened at the end of the US market session and just before the Asian markets began trading.
Only stock exchanges that were open at this time were Australia and New Zealand.
So with the thin volume of active traders in the market, this could have been an opportunity to run the stop losses and get everybody out at those levels or it what’s known as a “fat finger”.
Either way, it doesn’t matter what the cause was. End of the day, the British pound crashed more than 6% in a couple of seconds.
And today, the pound is at its lowest since January 2009.
Here’s what you can do to avoid wiping out your portfolio when a Flash-crash happens
Solution #1: Place a guaranteed stop loss and never worry about jumps again
Brokers like GT247.com, offer what’s known as a Guaranteed Stop Loss.
A Guaranteed Stop Loss is trading level you set. And if the market jumps (gaps) below your stop loss without getting you out, you will just be out at your original stop loss. And the market maker (broker) will take on the rest of your loss value.
Only thing with Guaranteed Stop Losses you need to remember, is the premium.
The premium can be anything up to 25 pips, to break even. So make sure you look at using it only when you’re trading higher time frames (4 hours and daily).
Solution #2: Don’t hold your Forex trades overnight
If you want total control of your Forex trades, you shouldn’t leave your trade for too long without checking up on it…
So, basically only hold a trade within the hours you wish to trade the Forex market.
Don’t hold any trade positions overnight, where you can’t control what happens to your trades.
This way you can keep an eye on how your trades do and sleep well knowing you’re not in a trade.
Solution #3: Risk a tiny percentage of your portfolio per trade
If you’re worried the Forex market will jump below your stop loss, prepare for the worst case scenario.
Only risk a tiny percentage of your portfolio, so that your portfolio can handle a bigger loss.
So if you risk 0.5% of your portfolio and the flash-crash occurs, you’d only look to risk around 10% of your entire portfolio.
This might sound like a very high percentage to risk, but remember something.
I’ve only seen these flash-crashes around three times in my life. And so this is definitely not a common occurrence. You just have to be prepared for when they happen.
Don’t expect to see this kind of action on a monthly or even a yearly basis.
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