By Derek Moore
May 6th, 2020
Today marks the 10-year anniversary of the infamous Flash Crash. Two things here, I cannot believe it has been ten years since the extreme dislocations in price occurred. But second, the lesson for many is still ingrained in investors and advisor’s memory of how unprotected some strategies were. Back in 2016 I had written an article on the Flash Crash and how some approaches responded on that day to the extreme volatility.
For this piece I have repurposed a lot of that material as the lessons and main points are the same today as then. One of the things I realize with each year I have been involved in the markets, now going on 27 years, is that many current investors or current advisors might not have even been investing 10 years ago. For those of you that remember and the investors that may not remember, here is a little refresher.
On May 6th, 2010, the Flash Crash happened. The markets were meandering along and around 2:30pm eastern time there was a huge drop in prices across indexes and more severely in exchange traded funds and individual stock names.
Consider the following chart from Vanguards Total Stock Market ETF: VTI
Source: Seeking Alpha
Keep in mind the Total Stock Market ETF in the chart above, has roughly 3500 stocks in it weighted by market cap and therefore it has broad market equity diversification. The price moved from roughly $57 down to $30 in minutes as you can see on the chart above. Remember, that chart is a single day’s trading. That represented about a -47% decline! To make it worse, some individual stocks traded down to pennies and the Dow Jones Index faired a little better as you can see in the chart below ONLY losing 9.2%. But again, that decline in the Dow was in minutes
.There has been plenty written analyzing the potential causes of that market event that you can find online. Many pointed to algorithmic computer trading as the issue then and they do still today.
Technical Analysis Too Late
Instances like this see markets move faster than any technical indicator can predict. Generally, using a technical analysis indicator would result in late selling (at depressed prices) and late buying (missing out). Put another way, you might end up selling at the lows and buying back at near the old highs resulting in a 10% loss in minutes.
Active management, as opposed to passive management, might also be too late to manage risk here. Active portfolio managers might run into the same problem as the people using technical indicators, selling near the lows and have to buy back near the high.
Buy & Hedge Strategies (And Reason for Buy and Hedge Book)
Regardless of the portfolio managers intensions, only portfolios with built in hedges provide real protection. Build in hedges is one of the reasons to choose ZEGA’s hedged equity strategies. Another reason is that all clients want to guard against catastrophic losses. In addition, some of those clients might not have the time to recover those losses and still provide the required assets in retirement. And perhaps the biggest reason for choosing a ZEGA hedged strategy is feeling secure – versus hoping your portfolio holds up in a crash. Why not actually have real defined protection that takes the “hope” out of the equation? This is one of the main reasons why ZEGA Co-Founders wrote the Buy and Hedge Book.