Best of the Week
Most Popular
1. Stock Markets and the History Chart of the End of the World (With Presidential Cycles) - 28th Aug 20
2.Google, Apple, Amazon, Facebook... AI Tech Stocks Buying Levels and Valuations Q3 2020 - 31st Aug 20
3.The Inflation Mega-trend is Going Hyper! - 11th Sep 20
4.Is this the End of Capitalism? - 13th Sep 20
5.What's Driving Gold, Silver and What's Next? - 3rd Sep 20
6.QE4EVER! - 9th Sep 20
7.Gold Price Trend Forecast Analysis - Part1 - 7th Sep 20
8.The Fed May “Cause” The Next Stock Market Crash - 3rd Sep 20
9.Bitcoin Price Crash - You Will be Suprised What Happens Next - 7th Sep 20
10.NVIDIA Stock Price Soars on RTX 3000 Cornering the GPU Market for next 2 years! - 3rd Sep 20
Last 7 days
Silver Bulls Will Be Handsomely Rewarded - 21st Sep 20
Fed Will Not Hike Rates For Years. Gold Should Like It - 21st Sep 20
US Financial Market Forecasts and Elliott Wave Analysis Resources - 21st Sep 20
How to Avoid Currency Exchange Risk during COVID - 21st Sep 20
Crude Oil – A Slight Move Higher Has Not Reversed The Bearish Trend - 20th Sep 20
Do This Instead Of Trying To Find The “Next Amazon” - 20th Sep 20
5 Significant Benefits of the MT4 Trading Platform for Forex Traders - 20th Sep 20
A Warning of Economic Collapse - 20th Sep 20
The Connection Between Stocks and the Economy is not What Most Investors Think - 19th Sep 20
A Virus So Deadly, The Government Has to Test You to See If You Have It - 19th Sep 20
Will Lagarde and Mnuchin Push Gold Higher? - 19th Sep 20
RTX 3080 Mania, Ebay Scalpers Crazy Prices £62,000 Trollers Insane Bids for a £649 GPU! - 19th Sep 20
A Greater Economic Depression For The 21st Century - 19th Sep 20
The United Floor in Stocks - 19th Sep 20
Mobile Gaming Market Trends And The Expected Future Developments - 19th Sep 20
The S&P 500 appears ready to correct, and that is a good thing - 18th Sep 20
It’s Go Time for Gold Price! Next Stop $2,250 - 18th Sep 20
Forget AMD RDNA2 and Buy Nvidia RTX 3080 FE GPU's NOW Before Price - 18th Sep 20
Best Back to School / University Black Face Masks Quick and Easy from Amazon - 18th Sep 20
3 Types of Loans to Buy an Existing Business - 18th Sep 20
How to tell Budgie Gender, Male or Female Sex for Young and Mature Parakeets - 18th Sep 20
Fasten Your Seatbelts Stock Market Make Or Break – Big Trends Ahead - 17th Sep 20
Peak Financialism And Post-Capitalist Economics - 17th Sep 20
Challenges of Working from Home - 17th Sep 20
Sheffield Heading for Coronavirus Lockdown as Covid Deaths Pass 432 - 17th Sep 20
What Does this Valuable Gold Miners Indicator Say Now? - 16th Sep 20
President Trump and Crimes Against Humanity - 16th Sep 20
Slow Economic Recovery from CoronaVirus Unlikely to Impede Strong Demand for Metals - 16th Sep 20
Why the Knives Are Out for Trump’s Fed Critic Judy Shelton - 16th Sep 20
Operation Moonshot: Get Ready for Millions of New COVAIDS Positives in the UK! - 16th Sep 20
Stock Market Approaching Correction Objective - 15th Sep 20
Look at This Big Reminder of Dot.com Stock Market Mania - 15th Sep 20
Three Key Principles for Successful Disruption Investors - 15th Sep 20
Billionaire Hedge Fund Manager Warns of 10% Inflation - 15th Sep 20
Gold Price Reaches $2,000 Amid Dollar Depreciation - 15th Sep 20
GLD, IAU Big Gold ETF Buying MIA - 14th Sep 20
Why Bill Gates Is Betting Millions on Synthetic Biology - 14th Sep 20
Stock Market SPY Expectations For The Rest Of September - 14th Sep 20
Gold Price Gann Angle Update - 14th Sep 20
Stock Market Recovery from the Sharp Correction Goes On - 14th Sep 20
Is this the End of Capitalism? - 13th Sep 20
The Silver Big Prize - 13th Sep 20
U.S. Shares Plunged. Is Gold Next? - 13th Sep 20
Why Are 7,500 Oil Barrels Floating on this London Lake? - 13th Sep 20
Sheffield 432 Covid-19 Deaths, Last City Centre Shop Before Next Lockdown - 13th Sep 20
Biden or Trump Will Keep The Money Spigots Open - 13th Sep 20
Gold And Silver Up, Down, Sideways, Up - 13th Sep 20
Does the Stock Market Really "See" the Future? - 12th Sept 20
Basel III and Gold, Silver and Platinum - 12th Sept 20
Tech Stocks FANG Index Nearing Critical Support – Could Breakout At Any Moment - 12th Sept 20
The Tech Stocks Quantum AI EXPLOSION is Coming! - 12th Sept 20
AMD Zen 3 Ryzen 4000 Questions Answered on Cores, Prices, Benchmarks and Threadripper Launch - 12th Sept 20
The Inflation Mega-trend is Going Hyper! - 11th Sep 20
Gold / Silver Ratio: Slowly I Toined… - 11th Sep 20
Stock Market Correction or Reversal? The Jury Isn't Out! - 11th Sep 20
Crude Oil – The Bearish Outlook Remains - 11th Sep 20
Crude Oil Breaks Lower – Sparking Fears Of Another Sub $30 Price Collapse - 11th Sep 20
Inflation by Fiat - 10th Sep 20
Unemployment Rate Drops. Will It Drag Gold Down? - 10th Sep 20
How Does The Global Economy Recover After This Global Pandemic? - 10th Sep 20
The Best Mobile Casino - 10th Sep 20

Market Oracle FREE Newsletter

How to Get Rich Investing in Stocks by Riding the Electron Wave

Why Some ETFs Led the Stock Markets Down Last Week

Stock-Markets / Stock Markets 2015 Aug 31, 2015 - 04:15 PM GMT

By: ...

Stock-Markets

MoneyMorning.com Shah Gilani writes: Of all the scary things that happened last Monday when the Dow Jones Industrial Average fell more than 1,000 points, nothing was scarier than what happened with exchange-traded funds (ETFs).

They crashed and exacerbated the market sell-off. They're not all a bad risk, and there are some we like to recommend that are quite safe – even essential – during a market reversal.


Investors need to understand exactly what it is they're holding. But this opens a can of worms Wall Street would rather leave shut tight, because there's a danger to investors from some of these.

Here's the truth…

Bad News for This Popular Investment

ETFs are supposed to be better than mutual funds because they trade all day like stocks, but we know now they don't trade all day.

They're essentially portfolios of stocks, bonds, futures, derivatives, and promissory notes that represent different markets or sectors, industries, commodities, asset classes, entire countries – you name it. There are ETF products designed to give investors exposure to just about anything an investor would want to take a position in – or against for that matter.

ETFs hold a portfolio of instruments – in our example, stocks. In order to determine the representative value of the ETF, meaning its fair market price, each of the underlying stocks in an ETF's portfolio have to be priced, weighted, and calculated together to get a net asset value (NAV).

Because there are buyers and sellers of every ETF, their moment-to-moment prices are moreover determined by trading activity.

Still, underneath the trading activity that can move prices up or down (to discounts or premiums to an ETF's NAV), there are arbitrage forces that generally keep ETF prices close to their NAVs. That's because traders can profit from the difference between an ETF's price and its NAV.

"Indicative values" or NAVs are usually posted every 15 minutes.

At least, that's the way it's supposed to work…

What Happened on "Black Monday"

But, on Aug. 24, hundreds of ETFs stopped trading. Not only that, when they did trade, their prices were so far out of whack they should have been made to stop trading.

The problem that surfaced on Monday was lots of stocks didn't open on a timely basis in the morning and lots of stocks were halted throughout the day when single-stock circuit breakers were triggered.

It's impossible to accurately price an ETF if one or more of the stocks underlying that ETF can't be priced because it's not trading.

On Monday, trading was halted in 1,300 stocks; almost 900 of them were ETFs.

So much for that all-day trading feature of ETFs…

But… temporarily halting trading on an ETF because its price falls 10% is a lot different than ETFs still trading while some of their underlying stocks have been halted.

Thousands of investors who owned ETFs and had stop-loss orders to sell their ETFs if they fell to lower prices got stopped out and sold their positions when those stop-loss prices were breached.

The truth is, most of them were artificially breached.

Because traders who work for ETF sponsors buy and sell ETF shares and underlying portfolio stocks to manage the correct balance of outstanding ETF shares and the corresponding number of underlying shares of portfolio stocks, they can end up holding ETF shares that are going down faster than they can liquidate underlying shares. Acting as "market-makers" in those ETFs, they can take a beating.

As market-makers, they are not going to hold up the bid for ETF shares if they don't know what the correct price should be. So, they widen their "spreads" and lower their bids. While they're stepping out of the way, sellers are frantically trying to sell their ETF shares. And there are no bids, or market-makers' bids are way below what they might be if a fair value could be determined. But no one knows what that fair value should be.

Some ETFs fell 35%, but when the dust settled they popped back higher, ending up only down maybe 5% or so.

All those investors who got taken out at lower prices were screwed.

However, their stops may not have been honestly triggered, and most of them took much bigger losses than they should have.

It turns out ETFs aren't as safe and liquid as investors were led to believe.

But it gets worse.

As markets are falling and investors are liquidating ETF shares and bids are falling and stocks are halted, market-makers are going to try and get ahead of falling prices of the shares and underlying stocks they have to sell into a falling market by, you guessed it, selling futures or whatever they can sell.

And to make a profit, knowing they have tons of ETFs and stocks to liquidate, they're going to short ahead of their selling.

Yes, I mean they have an incentive to get themselves short first, then liquidate ETF shares and stocks to push down the market they're short.

Nice trade if you can get it…

We Saw Something Similar in the First "Black Monday"

In a very real sense, what happened on Monday as ETFs were being liquidated and front-run by traders, and big sponsor market-makers were shorting before the open, is very similar to what happened in the October 1987 crash – which, coincidentally, was also called "Black Monday."

Way back then, the culprit was "portfolio insurance." That neat little product was thought up by sausage makers at the old Kidder Peabody.

But everyone else on the Street copied Kidder. The insurance plan amounted to a promise to sell futures contracts to protect portfolios from losing too much value since it would take more time to sell underlying stocks than for traders to sell futures first and then worry about liquidating stocks in a big market sell-off.

Well, it worked. Only it created a crash, too. When stock prices fell enough, to levels everyone selling portfolio insurance was watching, everyone began selling futures.

Massive futures selling triggered stock sales, which lowered price levels, which triggered more portfolio futures selling, which triggered stock investors to dump more stocks.

And so it was, portfolio insurance created the crash.

The same thing could happen with ETFs. They're an accident waiting to happen.

That doesn't make them bad products – not at all. But they do need some tweaking, and more importantly, investors need to understand completely what it is that they're holding.

Until the SEC recognizes the similarities between "portfolio insurance" and ETF liquidation realities (which will probably be on the Twelfth of Never), investors better prepare for what could be lots of mini- (and some) full-blown crashes to come.

Source http://moneymorning.com/2015/08/31/why-some-etfs-led-the-markets-down-last-week/

Money Morning/The Money Map Report

©2015 Monument Street Publishing. All Rights Reserved. Protected by copyright laws of the United States and international treaties. Any reproduction, copying, or redistribution (electronic or otherwise, including on the world wide web), of content from this website, in whole or in part, is strictly prohibited without the express written permission of Monument Street Publishing. 105 West Monument Street, Baltimore MD 21201, Email: customerservice@moneymorning.com

Disclaimer: Nothing published by Money Morning should be considered personalized investment advice. Although our employees may answer your general customer service questions, they are not licensed under securities laws to address your particular investment situation. No communication by our employees to you should be deemed as personalized investent advice. We expressly forbid our writers from having a financial interest in any security recommended to our readers. All of our employees and agents must wait 24 hours after on-line publication, or after the mailing of printed-only publication prior to following an initial recommendation. Any investments recommended by Money Morning should be made only after consulting with your investment advisor and only after reviewing the prospectus or financial statements of the company.


© 2005-2019 http://www.MarketOracle.co.uk - The Market Oracle is a FREE Daily Financial Markets Analysis & Forecasting online publication.


Post Comment

Only logged in users are allowed to post comments. Register/ Log in

6 Critical Money Making Rules