Stop-Loss Selling, High Intra-day Volatility & Market Depth

Regardless of your level of share trading, CFD trading or Forex trading experience, there are certain situations that require explanation when analysing short-term share, CFD and Forex trading.

One question that is often asked of TRUMarkets is, "Why did that stock price suddenly fall: is there something we should know"?

During any year, markets experience an increase in the occurrence of stocks, indices or FX suffering large intra-day movements (volatility). For the CFD day trader, this can mean that the stock opens then falls in excess of 3% to 5% to a low and then recovers to close near the open. This long 'tail' stands out when you look at the chart and can affect the application of future technical analysis.

As a larger proportion of these price fluctuations occur as 'tails' rather than a vertical 'wick' it is safe to assume that stop-loss selling causes them.

This is best explained by an example;

The charts above show ROC Oil in both a Daily (left) and Intra day (right) chart from the 21st March 2006; having opened at $3.22 it dropped 11% on stop loss selling before recovering 9.5% - all within a few minutes! The daily chart shows the long tail, and the intra-day chart shows the cascade of selling as stop losses are triggered in a domino effect. The subsequent buying takes the stock back to near its original price.

How does this affect you as a trader?

There are a couple of benefits to understanding how and why stop loss selling occurs;

• Firstly, if you are in a trade you may be able to avoid being caught out by a sudden drop,
• Secondly if you are lucky enough to see such a situation forming you may be able to place a buy order in such a position as to take advantage of it.

To do this you will need to look at the market liquidity demonstrated by market depth.

Market Depth

The table below shows the market depth of QBE, the left-hand green column are the buyers and the right hand pink column are the sellers. Although it does not appear to be in any danger of falling from the current price of $23.36, if a seller came into the market with 15,000 shares and wanted to get out regardless of price, the buyers would be taken to $23.21 - whilst only a fall of 0.7% it may then trigger a stream of stop loss orders, thereby taking the stock price further down. As there is no real fundamental reason why QBE would be at this level the buyers should appear and recover QBE back to around the $23.30 level.