Blogs > Your Money

Dave Patterson and Erin Preston, a father-daughter team of Certified Financial Planner® licensees, provide thoughts and suggestions on a broad collection of personal finance topics.  Information provided in this BLOG is intended to be of a general nature and may not be appropriate for all situations.  Readers should consult with their own financial advisors before relying on any information contained herein.

Sunday, May 30, 2010

How Should You Prepare for the Next “Flash Crash”?

Many of you are probably aware of the so-called “flash crash” that occurred on May 6th causing some shares to drop in value to as low as one penny in a matter of minutes. As of this writing, according to a Wall Street Journal report on Wednesday May 19, 2010 (“Flash Crash Plan: Circuit Breaker for Every Stock” by Fawn Johnson and Kristina Peterson), “regulators are exploring six hypotheses about the sudden plunge but haven’t pinpointed a single cause.”

Could another “flash crash” happen again? As noted in the aforementioned article, regulators are considering circuit breakers that would pause trading in any stock whose price dropped 10% or more in five minutes or less. Since the cause of the flash crash is yet undetermined, it’s unclear if the proposed circuit-breaker fix would actually prevent another similar incident.

It’s seems likely to us, that whether or not we have another “flash crash”, we can most certainly expect significant market “crashes” of one sort or another in the future. They might not be as severe in such a short time but they most assuredly will be gut wrenching.

So what should you do to prepare for whatever type of “crash” we experience down the road? Two things come to mind that we think make the most sense.

First, avoid getting caught up in the frenzy of a severe market downturn. Stay calm and let it happen. Don’t panic and sell in fear. Many who sold during the “flash crash” had their losses locked in as the market rapidly recovered. Timing the market is futile. We often see significant market drops followed a couple of days later by a similar–sized rally.

Second, when you sell stocks or exchange-traded funds (ETFs) , avoid using stop-loss orders. When the stop-loss price is reached, the order becomes a market order. During the “flash crash”, buy orders dried up, causing rapid drops in market prices, resulting in big losses for many stop-loss orders (in some cases 60% or more).

No matter what controls are put in place, we will continue to see substantial volatility in the markets, going forward. Keeping your emotions in check and avoiding the use of stop-loss orders should help you weather the storm.


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