Yesterday, we witnessed another episode of “Stocks Gone Wild“. This time the “outrageous and scandalous behaviour” occurred in an exchange traded note called the iPath optimised Currency Carry ETN, ticker symbol ICI. If you are not familiar with this product (and based on its usual low volume of 7000 shares a day, most people are not familiar with it), iPath describes it as:
“The index is designed to reflect the total return of an “Intelligent Carry Strategy,” which, through an objective and systematic methodology, seeks to capture the returns that are potentially available from a strategy of investing in high-yielding currencies with the exposure financed by borrowings in low-yielding currencies sometimes referred to as the “carry trade.”
Ahhh, the old carry trade is available in a neatly packaged ETN for all investors to participate in. Well, somebody must have gotten pretty excited about this ETN yesterday. It appears they placed a market order for several times the average daily volume of the ETN. In less than a minute, the price of the ETN went from $46 to $3,486. Whoops, looks like there were no circuit breakers enacted yet on this ETN. Since the price went up and not down, we like to refer to these situations as “flash dashes”.
This situation, while unusual, clearly demonstrates what could happen if a market order with no limit is placed in a security that does not have much posted liquidity. You may say, “This could never happen in an actively traded stock like Proctor and Gamble or Accenture“. May 6th of last year would have proved you wrong . But you may also say “Since then, the SEC has banned stub quotes and enacted 10% circuit breakers, so this can’t happen today?” And then you would be partially right. What could happen is that a heavily traded stock or ETF can still drop 10% in a matter of seconds on no news if the so called “liquidity” were to disappear. While it may not be as bad as yesterday’s iPath ETN flash dash, investor confidence would still be shattered. One of the most damaging aspects of May 6th was the speed of the decline and the rapid rise back. This violent move down and then back up in such a short period of time is what really damaged investor confidence.
There has been no rule enacted since May 6th that could prevent a 10% drop in seconds. These sharp moves are occurring because of the lack of real liquidity in today’s equity market. Many stocks appear highly liquid but at the first sign of trouble, this liquidity quickly disappears. Anybody who trades on a daily basis knows exactly what we are talking about. But heck, at least we still have penny spreads, right?