The danger of computerized “stop loss” orders. That’s my guess of what happened around 2:40 PM today. These are much more problematic than the short sale uptick rule. Let me explain.
Let’s say you bought a stock at $20 and has gone up to $35. You’re doing great, but you don’t want to “cash out” yet (which will incur taxes especially if you haven’t held the stock long enough yet for long term tax rates). So you don’t want to sell, but you want to protect yourself if the stock suddenly starts to drop. So you tell your stock broker to “put in a stop loss order at $30”. What this means is if a sale happens at $30 or less, the broker immediately sells yout stock to “get you out”.
The problem with this is people misunderstand what happens. When a trade happens at $30, your broker’s computer dumps in an order to “Sell at Market” the number of shares you said (probably all). That doesn’t mean you will GET $30 a share for your stock. By the time your order is matched, the price may be lower than $30. Your trade may go off at $25 a share… when that happens, any stop loss order between $25 and $30 will fire off and dump even more selling into the system – it’s like a nuclear reaction going critical.. There is no reaction time here – if nobody happens to be buying when this starts, the stock can go to zero in a few seconds. NASDAQ has announced it will break all trades at more than 60% below the prevailing price before the sudden drop as “erroneous”.
If your broker is smart enough and allows this type of order, you can put a limit on the stop loss – say “Stop loss at $30, but don’t sell for less than $28”. That protects you from an erroneous temporary drop in the trade price – but if it is a genuine drop and the price does not come back up to $28, you will not “get out” at all and be stuck with the entire loss, defeating the purpose of the stop loss order.
