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I'm looking to begin trading ES, and I'm confident in my ability to apply a sensible, conservative plan and stick to it. I've done a ton of practice on thinkorswim and I'm pleased with my performance. I'm also not overly worried about losing some or all of my risk capital. This is a side thing and not my source of income, and I'm treating it as true risk capital -- money that can vanish without impacting my situation in any way. What I'm worried about is the blowout scenario that is beyond my control. Two questions:
1) Say I'm plodding along, going for my little 2 or 3 point win on a 2 or 3 contract bet, and all of a sudden there's some crazy news or flash crash style event. I've got a stop in place but the decline is lighting fast. What exactly happens in a situation like this, in terms of financial fallout given the above trade parameters, if the market blows past my stop on the way to a meltdown? Like I said, if I lose $5K I'm not going to be devastated in the grand scheme of things, but if I'm on the hook for a $20K margin call, then I'm getting concerned.
2) If I commit at the outset to a short-only strategy, where I only take short bets and have a take profit order built in, say 5 points away, and my stop loss is wherever, say 3 points away, does this effectively immunize me from the lightning fast nightmare market decline? Presumably my TP order would be in hot demand by the people trying to get the hell out on the way down. Is this correct?
I'll throw my hat in the ring and provide (hopefully) some good info.
1) Liquidity is key in a flash crash situation. Thankfully, you're looking at the ES contracts which are one of, if not the most liquid market you can find. Now, never say never... but the event of an entire side of the order book vanishing/getting filled through (your worst case scenario for your stop) is very slim to none due to the massive liquidity that is always present in the ES order book (the bids/offers). Your stop loss that is 3 points away will get filled at the best available bid/offer but you might experience some severe slippage if the worst case scenario were to happen. It's hard to quantify the amount of slippage because personally, I have no idea what a flash crash would look like for the ES - I cannot recall off the top of my head that type of event ever happening where all the bids/offers get pulled and/or smashed through and cleared.
2) That is somewhat correct. Having a limit order in a short position will effectively fill your order at your target OR at an even better price. Stops (assuming your using a standard stop order) operate differently in that it will initiate a market order at the best available bid/offer that is there when your order gets executed. So yes, you will be covered if a market were to "flash crash" and you have a limit order to buy and cover your short position.
Ask yourself, if price is falling why is that? Are there no buyers? Are all the longs unwinding their positions and selling into the lack of buyers?
There's a lot of context and hypothetical scenarios around your example that may or may not make your TP order (a buy to close your short) to be in hot demand.
In that case your stop order would be enough protection for your entire account when considering the ES market. And in turn your TP limit order to close in profit would also be filled successfully protecting your risk.
It does immunise you against a nightmare market decline, yes. Depending on how your profit target order is executed, it might even result in some positive slippage in your favour.
But what if the market crashes upwards?
Admittedly this is historically unlikely, but it's the kind of risk scenario you should prepare for. You mention being comfortable with a 5k loss, but not a 20k margin call. If you reduce your position size to 25% of what's you're currently intending, that's a 5k margin call.
In reality, in extreme market conditions it's likely that you'll experience some considerable slippage on your market stop-loss order, but it's still unlikely to be significantly larger than your average loss - the ES is a really thick market - whatever is going on, there will likely be a large number of participants willing to take the other side of your order at a nearby price point.
Another exception to the above would be if the market goes locked limit. That's pretty rare in the ES. And if you're tracking the market intra-day then you're going to get some clear warning in terms of price action before it actually happens. It's always worth knowing what constitutes a lock limit move in your market though, and to include in your plan a condition to prevent initiating trades anywhere near it.
From the (totally legitimate) concern you've described, I would think that the best thing to do would be to examine some kind of extreme intra-day volatility and directional move criteria that will cause you to liquidate adverse positions and prevent initiation of new ones.
As long as you have your stop loss in place that is where it will get it executed. For your second question, that strategy is common. traders can tell where the stop losses are. Those moves are called a shake out.
On Friday afternoon I was doing some paper trading, and at one point I had a short position going, watching the little red candle do its back and forth dance. I was just about to close the trade because it wasn't moving with the gusto I was looking for, and before I could complete the click of my mouse I was looking at a green bar that must have been 4" high. Not a 'crash' of course, but it was violent. Both Trump and Powell were speaking that afternoon so maybe it had to do with that. Got a few good lessons from this little episode!
Always do your own research -- as a couple of posts higher shows, some people simply haven't a clue (no, stop orders are not in the public order book). Do your own due diligence.
The CME has no such thing as a true "buy/sell at any stop price" order. CME's stop order are actually "stop with protection." There is a protection band, and for the ES it is (or was, last time I checked) +/- 3 handles, which is added/subtracted from your stop price. Example: you are long and put a sell stop for 3000. If your order is triggered and market conditions are such that the best available bid to sell into is below 2997, you will have a sell limit sitting in the book at 2997, and will NOT get a fill unless someone takes your offer.
Trades can get busted, which means they get cancelled (usually fat fingers) and this is a discretionary decision of the CME's GCC, and no doubt is a messy situation (I have never had a trade busted personally).
It is unlikely that a small position will get into margin call territory -- if you are close to this, your position will be liquidated likely long before it is an issue. But as recent negative crude prices have shown, anything can happen. At this point, are you on the hook, or is your FCM? I don't know. You can virtually count this out in happening for a contract like ES, but as they say, anything can happen, and it's the risk you take trading a leveraged product.
If a lightening fast market decline occurs in your hypothetical scenario, yes, you are guaranteed a fill on your buy limit that is 5 points lower.
But a lightening fast decline can just as easily feature a spike upward that will trigger your buy stop first. In these scenarios, you will want to use an OCO order. This is either a broker/data feature implemented on their server, or is simulated locally with your software. That is, the CME does not have anything like "OCO" -- but if you submit an order to your broker specifying two orders, with one canceling the other, then your broker will cancel one, when the other is executed. In the cases of crappy brokers, your local software can simulate it. This is more unreliable, obviously. Is it possible for market conditions to be haywire enough that this does not function as expected (your broker, or locally)? You bet it is. What do you do about it? Nothing easy -- you accept this risk when trading.
How likely is it that one of these nightmare scenarios affects you? It's unlikely. But anything is possible.
Hopefully one of those lessons you got was: always know what's going on. Late Thursday and all day Friday was leading up to his presser on China (was announced early Friday that it was scheduled at 2pm, wound up being 40 mins late). I won't go into fundamentals vs. other stuff, but be clear -- the market was waiting on Trump, and if you didn't know that, it's like being at the table playing cards; everyone gets 2 cards, you think the game is blackjack, when it's actually hold'em. You simply must know this kind of market driver when it's this obvious. Best of luck to you!
