Can a stop loss fail if market is flooded with close orders? FinanceFeeds research

We research how retail brokers and clients would be affected if market volatility was high and stop losses were affected. The responses are quite surprising

So advanced are the ancillary trading systems now available to retail FX traders that concentration on very ordinary and fundamental activities such as setting a ‘Stop Loss’ or ‘Take Profit’ have become almost obsolete topics of conversation across the retail trading environment.

Ten years ago, retail brokerages would place a considerable emphasis on encouraging their clients – many of which were new to FX trading at that time – to set Stop Loss parameters on their platforms, and it was relatively commonplace to hear telephone conversations between sales and retention staff with their customers, majoring on Stop Loss functionality as a safety net to attempt to encourage clients to trade more or deposit more capital.

Indeed, most of the time, it is very clear that this has been a method of giving confidence to traders, however the execution methodology of a broker would have been tested at times of volatility and high market activity around market open and close times, especially with regard to how Stop Loss functionality is administered by brokers.

Today, FinanceFeeds spoke with a group of retail FX traders, some in the United Kingdom and some in Australia, who raised the subject.

“I know how currencies can take almost random turns at times inexplicably and crash many accounts. If everyone’s stop loss happens and tries to get out, couldn’t the brokers systems get overworked the same way if everyone is trying to get on the same website it times out?” asked one trader.

“What are the chances of this happening? I get it’s small but on the off chance it happens it would be bad especially on margins” he said.

Despite the MiFID II infrastructure requirements that have been foist upon many retail FX brokerages over the past two years and have included areas of execution and reporting as core functionality that has changed the way market makers, regulated exchanges and venues report and process trades, there is a lot of opaqueness surrounding how brokers adhere to stop losses.

We approached some retail FX brokers on this subject, and the answers were relatively generic. When asked if, at a time of high volatility or a flash crash, and lots of brokers and traders in the market all execute stop losses at the same time, what chance there would be of slippage or a stop loss not working due to overload or excessive dealing desk and risk management resources being used, Cyprus based easyMarkets said “We guarantee stop losses.”

This very anodyne response was not comprehensive, hence a further question was posed, that being to ask if all orders are b-booked and executed internally with no live market in order to achieve a guarantee on all stop losses. The answer was “it does not mean we have to b-book all orders” before the representative then concluded with no further information.

easyMarkets does, however, have the dealCancelation system which allows traders to emulate the ‘last look’ practices at the bank, which FinanceFeeds covered in detail here.

Israel-based AvaTrade, which is a very large retail FX brokerage that has offices in global locations and various regulatory licenses including under the European MiFID II rulings, gave a somewhat bizarre response.

When asked by FinanceFeeds whether a stop loss would be adhered to at a time of high market activity and lots of brokers and traders attempting to execute stop losses at the same time, the firm, which is completely focused on retail trading and employs over 300 staff, gave the most odd response, that being “Kindly note that we do not offer volatility.”

Given that FinanceFeeds engaged in several discussions with AvaTrade executives just over a year ago in order that they may seek advice on entering the institutional FX and liquidity provision sector and were unable to do so despite macro-level guidance being provided, this clearly demonstrates why that will never be part of their remit.

Alarmingly, when it was pointed out that this first of all makes on sense (brokers do not create volatility!) and that this was not the question, the representative said ” I did not understand the question, because in customer support are not educated in trading.”

Imagine if there was a very volatile event, such as the Swiss National Bank removing the peg on the EURCHF pair as they did a few years ago, and customers need answers to important questions such as this during a time of very high volatility, to be told by a customer-facing representative of a firm whose core business and only business activity is retail FX accounts and execution, that they are “not educated in trading”.

For a company whose slogan is “Trade with Confidence”, the irony is omnipresent.

FinanceFeeds then referred to another retail trader with significant experience, who said “Usually on volatile moves such as news or a flash crash this happens hence why most stop losses aren’t hit during those volatile movements.”

We then spoke to a trader in Canada who said “It is not likely at all in normal conditions. During news you can get slipped a bit but usually nothing crazy. During something like the CHF unpeg stops were pretty much ignored and price dropped over 2000 pips, brokers were margin calling a lot of people, and even making accounts negative (you owe the broker). It takes something catastrophic like that to get slipped more than 50 pips.”

Indeed, traders these days are using very high quality market analytics and have access to market depth indicators and predictive algorithms which have been part of the empowerment and education path of self-directed traders to the extent that nowadays clients of MetaTrader brokers are as astute as those of long established firms with proprietary trading systems.

Thus, it is telling indeed when a broker’s staff cannot answer questions about stop losses. It also demonstrates a likelihood that trade execution is conducted in house and no prime of prime brokerage or aggregated bank liquidity is in place, with sales staff concentrating on methods that do not belong in the FX industry, such as bonuses and calling clients for deposits.

Some traders have been relying on the functionality of Expert Advisors (EAs, or trading robots) to conduct stop losses rather than rely on the broker platform.

A trader in Australia said “Whilst it can happen, the odds aren’t that high, but you can just use an EA to basically go close all orders either as a backup (recommended for most people) or just as your main system so your broker doesn’t know your TP/SL values ahead of time, but going that route requires redundant computers as you’d be hosed if your own system goes down. So it’s best to just have the EA set to keep sending commands if there’s say a 5 pip deviation from your entered stop loss.”

Interesting indeed.

 

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