Anatomy of a Market Crash

Anatomy of a Market Crash - June 22, 22

Market Background

• Thursday Jun 9^th – S&P 500 index dives 2.35% in the afternoon as new inflation figures are released. Fears of higher interest rates to combat inflation grip the markets.
  • After the markets close, they are reclassified down to Yellow- Uptrend under Pressure.
• Friday Jun 10^th – S&P 500 drops another 2.9% as new consumer price index levels come in at highest points since December 1981 confirming inflation fears.
  • After the markets close, they are reclassified to Red – Market in Correction.
• Monday Jun 13^th – S&P 500 drops another 3.9%. Most of the damage is done at the open with the rest of the day trading nearly flat.

IES Trading

• Thursday’s market action happened while the markets were still Green. It wasn’t until 2 hours after the close that it was reclassified to Yellow.
  • IES trading rules don’t require a market exit on Yellow, merely caution.
  • One stock, AMPH, hit its downside stop and was sold out -12.5%.
  • We were caught a bit off guard by the reclassification to Yellow after the close.
• Friday, we made plans to buy-back AMPH, an excellent stock at an excellent price.
  • Meanwhile more bad news on the inflation front with the very poor CPI numbers knocking the market into another dive.
  • After the close, the market reclassified to Red. So, in two days the markets went from Green to Red – very unusual.
  • IES now had an exit problem. The Red designation meant an immediate market exit, but we couldn’t exit until Monday’s open.
• Monday we finally made our exit but not before programmed trading at the open drove prices down further
  • We sold into individual mini-rallies early in the session, but all the damage had already been done.
  • Our portfolio suffered a 9.32% loss, the largest single portfolio loss in IES’s 6-year history.
• Previously, IES’s largest portfolio losses had been:
  • -5.7% Jan 11 22
  • -5.1% May 14 20
  • -4.7% Jul 16 21
• The magnitude of this loss has caused us to re-evaluate our market exit rules and procedures to prevent and mitigate such losses in the future.

The End of Day Trap

A significant portion of our portfolio losses came because of what we have labeled the “End of Day Trap”.

Under normal market conditions, markets never go from Green to Yellow to Red in two days! Under normal market conditions, investors have time to react to Yellow markets and protect themselves from Red ones. But these are not normal market conditions.

The End of Day Trap occurs when markets are downgraded after the 4 PM market close. In our case we went from a Yellow market to a Red market after the close on Friday.

The problem is that the bulk of market trading happens either in the last half hour of the trading day or at the following days open. At the end of the day traders close their positions and bargain hunters try to take advantage of lower stock prices. At the following day session open, programmed trading automatically kicks in creating huge share transaction volumes.

Lessons Learned | System Changes

In volatile markets particularly, we must avoid getting caught in the “End of Day Trap”. Finding out that markets have reclassified after the 4 PM EST close of markets is not an option.

Further, we (IES) must not get distracted from watching its overall market position because of an individual stock at a bargain price.

We are making the following system changes to avoid End of Day Traps in the future.

1. Portfolio sell alerts will be issued at least an hour prior to the days market close – 3 PM EST or earlier.
2. Individual stock sell alerts will be issued at least an hour prior to the market close – 3 PM EST or earlier.
3. Market exit alerts because of reclassification to Red will also be issued no later than 3 PM EST.

In the case of Red market exits, we will be making an educated guess before 3 PM EST if the current days market action will likely reclassify the market downward. Since the official reclassification won’t usually be known until after 6 PM, we will be projecting the likelihood of a market upgrade. We will be going with the “Better safe than sorry” approach on this one.

Summary

• Going forward, for trade alert purposes, we will end our day at 3 PM or earlier. You will have time to react to trade instructions, same day.
• We will concentrate on overall portfolio management issues as opposed to stock buy-back opportunities.
• We will attempt to project any possible market condition changes before they occur and prior to 3 PM. Better safe than sorry!

Thanks for your attention.

As always, please contact me if you have any questions.

Duncan Campbell

[email protected]