The value of protective stops as US cocoa plunges in flash crash!

This week’s trading in Cocoa has reminded us all of two things, which we often forget as speculators. First, the value of a protective stop, and secondly, that no matter how good our analysis, sometimes we are just victims to events beyond our control. Such was the so called ‘flash crash’ in US Cocoa on Tuesday, which took my position out of the market in a matter of seconds, and for those of you who missed the story, here are the details from my own trading perspective, which are not pretty!

On Monday this week, I opened a trade in US Cocoa May futures just above $3,672, with a stop loss above the 3500 level, with the contract gaining steadily on Monday, and continuing higher on Tuesday morning. This was a longer term position which looked promising. At around 10.30 am US time, the Cocoa market suddenly plunged falling to $3,217 losing 12.5% of it’s value in just 60 seconds which in turn triggered a vast avalanche of stop loss orders adding to the turmoil. Within the next minute the market recovered returning to $3,600 in as many seconds, in a so called flash crash devastating the market and taking my position with it as a result.

This was similar to the event last May which saw Wall Street fall in much the same way. As you would expect, futures traders have demanded an enquiry as well as calls for so called ‘circuit breakers’ to be introduced which would then trigger a suspension in the market when certain price moves are exceeded with a given time. These are already in place in other soft commodities such as wheat, corn and soybean, along with oil, where the WTI contract stops trading if the price moves by more than $10 per barrel with a five minute period. Indeed, sugar traders have seen a similar mechanism introduced in the ICE raw sugar contract following concerns over volatility.

Of course many theories have been put forward for this event, from ‘choc finger’ to large sell orders, to trading algorithms, but no doubt, as always, the plunge and recovery will remain a mystery, as the markets move on and the dust settles. My own view is that all commodity markets should be protected in this way, but at least we are reminded from time to time of the need for protective stops. Yes, one could argue that the market recovered just as quickly – but that is with the value of hindsight. Suppose it had continued lower – a large proportion of my trading account would have been wiped out in minutes. So, whatever the reason, I lived to fight another day, slightly poorer, and retired with my cocoa which on Tuesday night had been fortified with a drop of the strong stuff!!!!