I would appreciate a feedback from traders familiar to the field on the following question.
In case of flash crash (or any very quick move), is the trader risking more than the margin? I have the feeling the answer is yes.
Let's suppose that the trader has an open position in futures (with a stop-loss) and a very quick crash occurs.
The stop-loss could probably not be executed at the required price.
The broker could liquidate the position.
The trader could lose his/her margin.
But... If the actual loss is greater than the margin, could the broker "take money" in the rest of the trading account?
If the actual loss is greater than the whole trading account, has the trader a "debt" towards the broker?
By reader IB's legal documents (extracts below), I have the feeling that the answer is "Yes". Any feedback would be appreciated!
If there is a flash crash or any other disruption of the exchange operation, such as a power failure, a plane hitting the exchange, etc. you will be stuck with your position. That position can not be liquidated, until the operation of the exchange resumes.
Once the operation resumes, your position can be liquidated for various reasons, for example
-> a stop that you have set is hit durinng the open (you will probably be able to remove that stop during the pre-open, if you still want to maintain the position, and want to avoid being hit by the high volatility during the opening phase)
-> the position is closed out by your broker, because you do not have a sufficient maintenance margin
-> the position is closed by the exchange, as some executions prior to the halt were cancelled
It is also possible that the exchange cancels some of your executions, which were intended to close a position prior to the interruption and that you will find yourself with an open position, although you think that you had closed it out.
In any of these cases, you may suffer from a loss, which by far exceeds the stop loss that you have set to protect you.
You are responsible for your actions and losses, and if your account is depleted, or if the loss you made exceeded the funds in your account, it is obvious that you need to reimburse the broker for the losses.
Different Types of Risk
As a trader you incur different types of risk, that need to be taken into account
-> market risk is well understood by traders
-> operational risk is less understood
Operational risk includes system failures, halt of exchange operations, failure of the Broker's software prohibiting order transmission, failure of data networks, failure of the server or PC you use to trade, etc.
All those risks are clearly at your expense.
How to cope with operational risk ?
Basically look for redundancy. Have ta least 2 PCs, a fixed and a mobile internet connection, use two different brokers, have access to two different exchanges.
Let us take for example the NYMEX failure on February 13. If you got stuck with a short position prior to the failure of the exchange, you could have hedged that position with a long WTI position on the IPE in London. A hedge is never a perfect protection against risk, but it is clearly reducing the market risk your are exposed to.
Another option would have been to go long USO via Arcanet.
Too bad, if your broker interferes with your attempt to hedge your possition, because you cannot keep your margin requirements. You need to make sure that you do not trade size, when you can't afford it.
The following 12 users say Thank You to Fat Tails for this post: