By Pam Martens and Russ Martens: February 7, 2018
On Monday afternoon, the Dow Jones Industrial Average was trading down about 700 points. Over the next 11 minutes, it fell more than 800 points in what can only be described as a Flash Crash as the Dow abruptly recovered to pare its loss from down 1,597 points to a final close of down 1,175 points on the day. Small investors who had stop-loss orders in place saw those orders triggered and their stocks sold, only to see their stocks recover much of those losses within minutes. This was eerily reminiscent of the Flash Crashes on May 6, 2010 and August 24, 2015.
Small investors (as well as institutional investors like municipal pension funds who work for the little guy) frequently have in place standing stop-loss orders that sit on the stock exchange order books to sell a stock at a pre-determined exit price that is lower than the current market. This is meant to “stop” further losses. Once the target price of the stop-loss order is reached, the order automatically becomes a market order and is executed at where the market happens to be. In orderly markets, this would typically mean the stop-loss order would be executed at, or close to, the designated target price. In flash-crash markets, on the other hand, it’s an open invitation to be fleeced.
In the Flash Crash of May 6, 2010, the Dow plunged 998 points and then closed the day with a loss of just 348 points. The Chair of the Securities and Exchange Commission at that time was Mary Schapiro. In a speech later in the year, Schapiro revealed the devastating impact the triggering of those stop-loss orders had on investors. Speaking at the Economic Club of New York on September 7, 2010, Schapiro said this:
“A staggering total of more than $2 billion in individual investor stop loss orders is estimated to have been triggered during the half hour between 2:30 and 3 p.m. on May 6. As a hypothetical illustration, if each of those orders were executed at a very conservative estimate of 10 per cent less than the closing price, then those individual investors suffered losses of more than $200 million compared to the closing price on that day.”
On Monday, August 24, 2015 the Dow Jones Industrial Average plunged 1089 points within the first few minutes of trading. Close to half of that loss was recovered by the closing bell with the Dow losing 588 points.
Is there any basis to believe that Wall Street traders would intentionally collude to trigger stop-loss orders going off in order to book profits for their firms and big bonuses for themselves? In fact, just nine days ago a Federal regulator, the Commodity Futures Trading Commission, charged Deutsche Bank AG, Deutsche Bank Securities and UBS with allowing their traders to intentionally trigger stop-loss orders to benefit their firms. With regard to Deutsche, the CFTC said in its complaint:
“between December 2009 through February 2012, DB AG, by and through the acts of one of the Traders in Singapore, placed orders and executed trades with the intent of manipulating the price of precious metals futures contracts for the purpose of triggering customers’ stop-loss orders. This DB AG trader coordinated his trading with another precious metals trader at another large financial institution (‘Financial Institution 1’). On certain occasions, the DB AG trader was successful at manipulating the price and triggering the customer-stop loss orders. Intentionally triggering the customer stop-loss orders on some of these occasions allowed the DB AG trader to buy precious metals futures contracts at artificially low prices or sell precious metals futures contracts at artificially high prices for the benefit of his proprietary trading.”
UBS was charged with almost identical language by the CFTC in the stop-loss matter but the word “successful” is left out, leaving the public to wonder if the UBS trader simply colluded with another trader at another firm and didn’t actually make any money for his own firm.
While the conduct in these charges involve the precious metals markets, the same actions are easy to replicate in the stock market and the futures markets that impact stock prices.
These latest charges come on the heels of Wall Street banks being previously charged with rigging Libor, the interest rate benchmark that is used to set a multitude of consumer loans, and rigging foreign exchange trading.
Bringing charges of stock market manipulation would fall under the auspices of the Securities and Exchange Commission. Under the Securities Exchange Act of 1934, codified at 15 U.S. Code § 78f, the Securities and Exchange Commission is statutorily mandated to ensure that the rules of the stock exchanges are designed “to prevent fraudulent and manipulative acts and practices, to promote just and equitable principles of trade…to remove impediments to and perfect the mechanism of a free and open market and a national market system, and, in general, to protect investors and the public interest; …”
On March 30, 2014 Michael Lewis, a veteran of Wall Street and bestselling author, went on 60 Minutes to provide a play-by-play analysis of how the stock market is rigged. The interview came in conjunction with the release of his bombshell book, Flash Boys, which focused on the manipulative role of high frequency traders and how the Wall Street banks and stock exchanges had gotten in bed with them.
We wrote at the time:
“Not only are the New York Stock Exchange and Nasdaq allowing high frequency traders to co-locate their computers next to the main computers of the exchanges to gain a speed advantage over other customers at a monthly cost that only the rich can afford, but they’re now tacking on infrastructure charges that price everyone out of efficient use of the exchanges except the very top tier of trading firms. This filing by the SEC in the Federal Register proves that the SEC is not only aware of the practice but has thoroughly embraced it.”
Lewis noted in Flash Boys that “both Nasdaq and the New York Stock Exchange announced that they had widened the pipe that carried information between the HFT [high frequency trading] computers and each exchange’s matching engine. The price for the new pipe was $40,000 a month, up from the $25,000 a month the HFT firms had been paying for the old, smaller pipe.”
Next month will mark the fourth anniversary of the 60 Minutes “stock market is rigged” program. The SEC has done nothing to halt the trading in Wall Street’s dark pools; has done nothing to level the playing field at the stock exchanges; and has given little more than lip service to ending manipulative high frequency trading practices. (See related articles below.) Even more dangerous, the Trump administration is looking for ways to make Wall Street even less accountable by rolling back the weak safeguards that currently exist.
As long as this deregulatory attitude persists, the small investor really has to be his own advocate and watchdog.