E-Trade would have probably liquidated a stock if they had the chance to do it.
However, when the trading of a stock is halted because of major announcement, the broker cannot liquidate it.
Once the shorted stock reopens with a gap up, the damage to the account is already done, and it is too late to liquidate the position.
The simple problem here is that the trader needs to understand that short selling stocks can be extremely dangerous.
-> a single stock can easily make moves of 30% or 50%
-> the markets cannot be traded 24/24
-> sometimes too many traders have shorted the same stock and there can be a short squeeze on top of that
When you trade futures there are not so many black swans. An index such as ES does not jump up 30% overnight, and also the exchange is open overnight, and the broker can indeed liquidate the position, before the account is depleted.
When you short crude oil, this is not more dangerous than going long - if you leave your position a few days prior to expiry of the contract. When you short a stock index, this is pretty safe to do. I have never seen stock indices gap to the upside by 10% or more.
However, when you short a stock, there is illimited risk. During the takeover battle with Porsche, Volkswagen stock moved up from € 150 to € 1,000 and Volkswagen became the most valuable company in the world for a few days. A few hedge funds who had shorted the stock had severe problems, as the freefloat of the stock is limited.
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It was not halted, according to this guy broker wasn't even aware of the margin call, being so fast and after hours event. I would argue that futures are less dangerous if you account for the fact that generally much smaller typical volatility will require using high leverage to get comparable result with stocks as biotech. And while shorts are not more dangerous than longs in futures it is because longs are as dangerous as shorts in a highly leveraged position.
Yeah, he sold stock short and it went up 1000% while it could not go down more than 100% in case of long. But if you buy or sell futures and lever 100 to one you just need 1% move to wipe you out be it short or long.
Ultimately it is not a market fail, just a case of greed and inadequate capital protection. He clearly was hoping for a stock to lose maybe 50%, used half of his capital i.e. delevered 0.5 to one, and was hoping to get 25% gain on trade. If he would plan to get a conservative 2.5% gain he would delevered 0.05 to one and invest only 1600 into position not 16k. Then he would lose only 13k in the same circumstances
I agree that futures require appropriate risk management as the position is always leveraged. However, you cannot leverage genuine futures 1:100 as the maximum leverage is limited my the margin requirements set both by the exchange and your broker.
The case of a leverage of 1:100 rather applies to FOREX retail brokers outside the US, as leverage in the US is limited to 1:50.
When I mentioned that shorting stock is dangerous, I was talking about black swans. A takeover announcement, a new drug or a short squeeze can move a small stock up by a few 100%. Someone shorting stock needs to take into account that risk by limiting exposure in such a way that a black swan event cannot kill the account.
When shorting an index future the black swan is a sudden move up of 4%. When shorting a stock, the black swan is a sudden move up of 400%. Therefore you might have a higher exposure to black swan risk when shorting a small stock compared to short futures position.
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It is not a question is there limits by the exchange or circuit breakers or your hope ES will not jump overnight. It is a question of buyers and sellers. The question is anybody willing to sell or buy that you can go out of your position or your broker can liquidate it.
If sellers will disappear it is nobody's fault and it is a situation what cannot be fixed in any way than hedging if you are lucky enough to find a suitable instrument which is tradeable.
btw. This was exactly what happened for example on the black monday morning in 1987 in S&P 500 index futures.
In index futures you can loose easily more than your account in both ways long or short !
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Thank you for taking a different view. That allows for discussing the item.
What I wanted to say is that the most dangerous situation comes up, when there is a large move while the exchange is closed or halted. In this case a stop loss cannot save you, because it cannot be executed.
When there is a takeover announcement for a promising stock, and you hold a short position of that stock, you are trapped. Your may easily find yourself with losses of 100% of the principal or more. Of course, if you hold a highly leveraged position in futures, there is a risk as well. But, in general, the probability that your stop loss will be executed is better for futures contracts.
-> futures have longer market hours
-> the liquidity of the futures is better (in terms of value)
-> executions are better in case of a major problem
Let us have a look at the flash crash (the last black swan):
-> a drop in Asian markets caused a first decline of 7% prior to the regular open, with a futures positions and a stop loss you could have already exited overnight
-> the futures market was liquid enough prior to the open
-> for NYSE listed stocks there were no quotes for several minutes
-> at the regular open already 765 stocks of the Russell 3000 were down over 10%
-> some stocks lost 60% of their value, because there were no buyers
-> NYSE and NASDAQ market data was delayed by 15 minutes, because the computer systems would not process the trades
-> CME was moe or less up-to-date (see NANEX reports)
Summarizing: Your stop loss would have been certainly honored at CME futures, which means that you would have been able to control your risk all the time, including the early period when the Asian markets were open. Stocks were not tradeable during the Asian market hours, did not produce any quotes at the open, suffered from a sudden loss of 10% and more. During the remainder of the session market data for stocks was delayed by 15 minutes. How would you have managed your risk under those conditions? Even diversifiying your stock portfolio would not have helped you.
I beg to differ - 400 usd daytrading margin for ES is a regular thing among discount brokers, that is higher that 100 to 1. 1% move withing a minute or two even in ES during a regular session - happens, just recall August. While moves like we had in KBIO in just few overnight hours are unprecedented.
If we look for FDAX futures - I witnessed over 5% move in just one tick prior to ECB announcement. Market was halted for 15 minutes. Some transaction were cancelled some not. Again discount brokers like Ninja or AMP gladly give you 2500 usd day trading margin while notional value of the contract is 11000 x 25 = 265 000 euro. Fully levered it would have you had with 400% margin call after your equity expired.
Trade to live. Not live to trade.
Last edited by xelaar; November 21st, 2015 at 02:20 PM.
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Survival of the fittest. Brokers like that take on extra risk in exchange for attracting more accounts.
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I agree with you. Super discount brokers are playing a dangerous game to acquire new customers. My broker requires an intraday margin of $ 2875 and an overnight margin of $ 5750 per contract, well above the $ 400 daytrading margin that you mentioned. I am not sensitive to the margin offers of discount brokers, because they are in contradiction with my own principles of leverage and money management.
But it seems that brokers offer those ridiculuos margins because they believe that it is easy to cover a futures position in time and limit their own risk.
Obviously, I was not comparing over-leveraged futures positions to stock positions.
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