The Trader’s Emergency Survival Plan

(Note: This was originally posted on September 30th, 2011 but the events described within could happen again tomorrow).

As soon as the market opened today, social media and trading chat rooms blew up with reports about various platforms going down, making them unavailable to place trades.  Frantic statements like, “I can’t close my positions out,” “my screen is frozen,” and “I am losing thousands right now,” were flying left and right.

The first thing you need to be aware of when trading on-line is that when there are technical problems like this, you are on your own.

The agreements you sign when you open a brokerage account specifically state that the broker-dealer is not responsible for technical issues related to platform functionality, connection problems with the exchange, or data feeds.  This applies to their own technical issues as well as any technical issue their vendors may have.

Sure, if you call customer service and complain loud enough you may get some free trades or a toaster, but they are not going to refund you the five grand you lost because you could not close your position.

The second thing you need to know is that technical problems will happen at exactly the worst moment. It’s kind of a self-fulfilling process.

Imagine there is some terrible terrorist attack overnight, and everybody and their brother panics and decides to sell their positions as soon as the market opens.  A massive wave of sell orders hits your broker’s site, crashing it.  Those same sell orders are driving the market down, causing more people to sell and sending the market into a free fall.

This is the time you need to get out of your position most, but you can’t.  Believe me, it sucks.

But it doesn’t have to be something so dramatic for problems to arise. For example, brokers often roll new code or system upgrades overnight, and although they test the best they can to make sure everything is stable, sometimes an issue will not show up until the rush of opening orders hits their servers the next morning.

However, broker issues are not the only things that can cut off your ability to trade, so if you want to do everything you can to try and survive when the shit hits the fan, I suggest you consider the following:

Backup

In our modern world, especially if you live in major urban centers, we rarely give a thought to losing power, however, it still happens.  Just a couple of weeks ago, a major part of San Diego County lost power for a number of hours.  No matter if it is a line worker who hits the wrong switch or a fuse blows out in your house or office, there is always a risk of an unexpected power outage.

Go to Best Buy or Amazon and get yourself a UPS battery backup unit.  You don’t need the one that will power your whole house; you just need one that can give you 15-30 minutes of battery backup.  Once you get it, make sure you plug your CPU, your internet modem, your wireless router, and at least one monitor into the battery backup plugs.  This will enable you to stay up and running and give you enough time to flatten out a position or at least put a stop order in if you lose power.

Redundancy

Even with no broker issues and full power, your internet connection can go down, leaving you at the mercy of the markets.  If you have access to a fiber optic service like Verizon’s FIO’s you should seriously look at signing up.  It is extremely fast and has almost zero downtime.  But no matter what type of internet access you have, you should definitely have redundancy in the form of a separate provider.

Don’t be penny wise and pound foolish; just pay the extra fifty bucks a month to have a backup connection.  Even if you never need to use it, it’s great piece of mind to know that if your DSL goes out; you can just switch CAT 5 cables and have your cable internet kick right back in.  (It should go without saying that you should have the CAT 5 cable to your alternate service clipped to the back of your router or computer for a quick switchover).

Duplication

Online trading is so frictionless that there’s no reason to have all your trading funds with one broker.  Split your funds up 50/50 or 30/70 between your primary broker and your secondary broker.  Then, unless there is a complete failure on the exchange systems themselves, something which is almost unheard of (and if it happens you are screwed either way), you have a backup way to flatten a position.

Say you are long 500 shares of XYZ and you lose access to your broker’s platform.  If they market starts to tank, you can go onto your secondary brokerage account and sell 500 shares of XYZ short, effectively making you flat on the position, which you can unwind when things return back to normal.  Sure you will pay a couple extra commissions, but what does that matter if it saved you hundreds or thousands.

Go Mobile

If your internet connection goes down and it’s not an exchange problem, you still should be able to close a position out on your broker’s mobile app, possibly even if they are having problems with their desktop platform. Point is, make sure your brokerage app is download and you phone is close to your trading desk at all times.

Bonus Tip

If you ever happen to fat finger a trade, over buying or selling a position, close it out immediately.  If you are a trader, you have to analyze situations fast, and then take quick, non-emotional actions, and this is a perfect example of when you need to do that.

And even if you think the mistake was caused by a broker’s trading platform, close the position first, investigate later. Here’s why.

How long will it take you to pick up the phone, get through to your broker’s customer service department, have them contact their order desk, and then the exchange?  Do you want an open oversized position out there for all that time, possibly going against you hard, only to find out that the broker/exchange won’t break the trade?

Trust me, kill the trade immediately, then call your broker’s customer support line and explain the situation.  If you are a good customer, and the loss is not too big, you have a decent chance of them scratching it for you or at least giving you some free trades to compensate. Or a toaster.

3 Ways The Exchanges Screw With Your Stop Orders

There are a number of topics that come up on a regular basis among traders, but one of the most prevalent is “how the markets are rigged.”

Well, I can tell you with 100% certainty, they are rigged. Plain and simple, the markets, specifically the exchanges, are totally geared towards screwing the retail investor.

The key though is not to engage in some quixotic attempt to change things, but to educated yourself as to how it is rigged, and then use that knowledge to your advantage.  So, in that spirit, let me fill you in on the three most common ways you can get screwed when using stop orders. [Note: when referring to stop orders going forward I’m referencing a standard, plain vanilla stop order, opposed to a stop limit order.]

1.  Triggering stops without a trade –  For example, XYZ is currently trading at $20.50, and you have a stop order in to sell at $20.00.  Price approaches your stop and it gets triggered and you are filled at $20.05.  But when you look at your chart, you see that the lowest trade price was $20.04.  So how was your stop triggered?

When you put a stop order in, what you are doing is placing a market order, which for lack of a better word, is in a “suspended” state.  It is not active until your stop, or trigger price, is hit. Once it is, your market order is then live, and acts like any other market order.

But what you might not know is that there does not have to be an actual trade at your stop price in order to trigger the market order.  Only a quote needs to be shown at your stop price in order to trigger your order, which can then be filled at wherever price the market is trading at.

2.  Reprioritizing your order –  When there are two stop orders at the same price sitting on an exchange, the priority goes to the one that was placed first.  So if XYZ is trading at $20.50, and there are two stop market orders at $20.00, when price comes down and triggers those stops, the one that was placed first will get filled before the other one.

However, this all changes if there are stop limit orders at the same price.  Stop limit orders at the same price as a stop order will get priority, and will be filled first, even if they were placed after the stop order.  In fact, stop limit orders below the price of stop market order can still get priority over a stop order.

The “philosophy” behind this exchange rule is that by placing a stop order you are accepting the possibility of getting filled “where the market is trading”.  But with a stop limit order, you are only willing to accept a fill at a specific price or better.  If price is falling fast and triggers a $20.00 stop order, turning it into a market order, then continues to $19.98 before filling that market order, a stop limit at $19.98 will get filled first. And if there is no more liquidity at that price and it drops to $19.96 before filling the market (formerly stop) order, limit orders at $19.96 will get priority over it as well.

As you can see, in a fast market, especially in thin stocks, your stop order can trigger, drop significantly and remain open, while stop limit orders are getting filled in front of it.

3.  Midday stop hunting –  Often, during the middle of the day, you’ll see stocks dip and run stops, usually below obvious support levels, only to reverse immediately and begin climbing.  This occurs because there is a tendency for liquidity to dry up during the middle of the day, which means less volume is needed in order to move a stock.

I hear complaints all the time from people who lament their stops being run, and then usually adding “and this stock trades seven million shares a day,” the implication being that the stock is too liquid to manipulate.  But what they don’t realize is that the vast majority of volume takes place in the first and last 30 minutes of the trading day.  Sometimes 50% or more of as stock’s total daily volume takes place during these time periods.  That leaves 5.5 hours of relatively light volume, where price can more easily be manipulated towards pockets of stops.

There is a common theme running through all three of these issues.  Can you guess what it is?  The exchanges run on volume, so for them, the more the better.  And in each of the three scenarios above, the framework is designed to create as much volume as possible.

If price can’t trade low enough to trigger a transaction, just throw a quote out, trigger the stops, and unlock the volume.

What a tragedy it would be if falling prices bypassed limit orders, failing to trigger a trade? So why not facilitate the best opportunity to create transactions by prioritizing limit orders over market (formerly stop) orders, which don’t have to be filled at a specific price?

And low volume periods during the day allow easier price manipulation and the ability to “clear out” areas where stops congregate.

UPDATE: Reader’s comments below:

______________________________

@StockTickr writes…

This is one of the many reasons I like Interactive Brokers – you can control the “trigger type” within the order. See the “Trigger Method” section on this page:

http://www.interactivebrokers.com/php/apiUsersGuide/apiguide/activex/iorder.htm

@SPEEROTHEKID says…

As a day trader I don’t use hard stops at all for this very reason….

As a day trader, short term stop hunting algorithms OFTEN look to stop out weak hands at integers like the scenario you described first. Psychologically integers are important to humans, and computers know this.

BigJ writes….

The only alternative I know of is at my brokerage, TD Ameritrade. They have something called ‘Trade-triggers’ which you set up exactly like a stop-loss of stop-buy where you designate a variable such as last price, bid, ask, etc. along with a trigger or activation price. Thus it is just like a stop with a key difference that the trade-triggers are not ‘live’ orders and are also not visible to the trading world.

@HotPh.dStripper adds…..

bclund you are so hot.  Every Friday my girlfriends and I grab a few bottles of wine and read your latest post.  How can someone so smart and insightful be SO DAMM sexy.  We want you to join us next Friday, so we can “run your stops”….!

@MITmassuse chimes in…..

Forget Ph.d Stripper, becuase I can make you feel sooooo good.  Explain weighted moving averages to me and I am all yours.

@RikersAlumni says….

Loved your post with the “naked men in pit of honey“.  Coming to see you soon.  I think we can have a lot of fun….

How To Bring A Loved One Back From The Dead.

When the person you love most dies, it doesn’t hurt. The word “hurt” implies that you feel something. The truth is, all you really feel is numb.

I had two years to prepare for the death of my father. The clock began ticking the day the phone rang in my homeroom class during my senior of high school.

It was a wall mounted rotary phone that could only be used to communicate with the administration office and my teacher answered, listened intently, then hung up.

“You need to go to the front office, there’s a call for you,” he said.

Arriving at the office, I picked up the phone and heard my mother’s voice. She began to give me the “facts” in her WASPy style, a style which I’ve heard come out of my own mouth too often in the ensuing years.

It’s a measured, concerned type of tone that attempts to convey the message, “yes, we have a situation here, but let’s take it step by step and not get ahead of ourselves.”

I hung in with her until the part about a brain tumor. Everything after that’s a blank.

During a presentation at his office, my father had frozen on a word. He couldn’t get it out. Then he had a seizure and fell to the floor.

He was rushed to the hospital and given a CAT scan, which found the source of the problem. One of those annoying cancerous tumors had decided it would call his brain home.

The following two years had moments of sorrow and pain, and surprisingly, joy as well. But still, nothing in those twenty-four months could prepare me for the day we lowered his casket into the ground.

In the twenty-five years since, I have thought about my father often. He was the greatest person I’d ever known.

At the time of his death, I loved him more than I loved anyone else in my life, and only with the birth of my children have I loved someone more. He was like me, but without the asshole part, possessing all my good traits and none of my flaws.

Eventually, I accepted the fact that he wouldn’t there with me for the important and special events in my life. Yet the only thing that I could never come to terms with was that he would never get to meet my children–or they him.

Then something amazing happened. Something I never would have expected. Something I never would have believed. I had a dream.

Once, at a party I was attending, I noticed a large group of people surrounding a lady who was clearly holding court. As I listened to the conversation, I realized that she was doing dream interpretations. Enthusiastic and hopeful believers were peppering her with all sorts of questions, trying to discover the hidden meaning in their dreams.

Questions about unicorns, and rainbows, and swimming with dolphins. I walked right into the middle of the circle and said to her with a straight face, “Last night, I had a dream I was in a pit of naked men, covered in honey. What do you think that means?”

Suffice to say, that’s generally how I feel about dream interpretation. But this dream was different. It was a powerful dream. A dream where you not only see, hear, and smell the people it in, but you feel them.

In this dream, I was at home with my wife. My daughter was playing in the yard. With her grandfather. My father. There he was, albeit somewhat older, doing his patented “I’ve got your nose” gag, and making her squeal with laughter.

I watched from inside the house as my wife went about making dinner. It did not strike me as unusual that my father was alive, well, and playing with his four-year-old granddaughter. I just felt a sense of calm, of peace, and of all things being right with the world.

Then in an instant, everything changed.

Suddenly, my daughter turned and ran into the street. A sense of fear and dread that only a parent can understand ran through me. I saw cars at the end of the street coming her way. I saw the joy of my life ending. I saw my reason for living gone.

Almost instantly, my father ran after her. I bolted out of the house, but he had a head start and was closer. She ran down the street and though he tried, he could not catch up with her.

I pushed my legs furiously, watching the cars that were closing in on her, and I knew time was running out. I passed up my father and came within a few feet of her. Just as I thought everything was lost, I made a mad lunge forward — stretching out as far as I could — and scooped her up into my arms and to safety.

I awoke to a stillness in my bedroom that clashed with the frenzied dream, and at first I was disoriented. Slowly, I began the process of coming back to reality – the part where you remind yourself that “it was only a dream.”

Then something inside made me stop. Something made me not only want to hold onto the dream, but to make it real. So, for the first and only time in my life, I chose the Orwellian concept of “doublethink” — choosing to not only believe something untrue is true, but actively forgetting the decision to do it — thus making it a reality.

I chose to believe that my father had visited and played with my daughter because the feelings in my dream were as real and valid as anything I’d ever felt in my life.

I also chose to understand that my father chasing after my daughter, and I passing him up and bringing her to safety, was a metaphor.

That the days when I watched him at his workbench, slowly and steadily bringing to life some project that my young mind couldn’t fathom, were, despite how much I longed for them to linger, gone forever.

That I had gone from being the admirer to the admired. From the protected to the protector. It was a message telling me that I had passed from being just a son, to being a father in my own right.

The dream also helped me understand that my children could “meet” my father every day, through me, from the parts of me that were from him.

It’s years later and I now have a two-year-old son. As I watch him play, and learn, and grow, I look forward to the day my father comes to visit him as well.