Lesson 14 of 25 · 7 min
A currency peg removed, January 2015: overnight gaps and retail margin
A stop order is an instruction to trade at a price, not a guarantee that the price will exist.
From September 2011 the euro could not fall below 1.20 Swiss francs, because a central bank stood ready to sell francs without limit to prevent it. On 15 January 2015 that floor was removed. Within minutes the rate was reported to have traded close to 0.85 before settling near parity, a move widely reported at roughly thirty percent intraday.
Three and a half years of a stable, bounded price had been read by many systems as low volatility, and low volatility is what sets a margin requirement. Retail foreign-exchange accounts in some jurisdictions were financed at fifty or a hundred times the cash posted, a ratio that is only survivable if the price moves in small continuous steps.
It did not. A gap is a price move with no trading in between, and a stop order is an instruction to trade once a level is reached, filled at the next available price rather than the level named. When the next available price is twenty percent away, the loss is set by the gap and not by where the stop was placed. Accounts went to negative balances.
The consequences ran up the chain. A number of retail brokers reported client losses exceeding the equity in those accounts, and therefore losses of their own; one required emergency funding and another was wound down. Several jurisdictions subsequently limited retail leverage and required negative-balance protection, which reallocates the tail to the broker.
Measured volatility describes the past behaviour of a mechanism. When the mechanism is an administered floor, its history says nothing about the day it is removed.
Key terms
- Gap
- A jump from one price to another with no trades in between. Stops, limits and hedges all assume a continuous path, and a gap removes it.
- Slippage on a stop
- The difference between the level at which a stop was triggered and the price at which it was actually filled.
- Negative balance
- An account whose losses exceed the cash in it, leaving the holder owing the broker. Possible whenever leverage is high and a gap is larger than the margin.
Worked example
A stop that could not be filled where it was placed
Illustrative figures scaled down so the arithmetic is followable; they are not the reported amounts. A long position of 250,000 units of a currency pair entered at 1.2015 against $6,000 of equity, with a stop at 1.1900, when the market gaps to 0.9800.
- Effective leverage
- about 50x
- Loss the stop was meant to cap
- $2,875
- Price at the first available fill
- 0.9800
- Realised loss
- $55,375
- Account balance after the fill
- −$49,375
- Realised loss against the planned loss
- 19.3x
250,000 × 1.2015 of exposure against $6,000.
250,000 × (1.2015 − 1.1900).
No trades occurred between 1.1900 and here.
250,000 × (1.2015 − 0.9800).
$6,000 − $55,375.
$55,375 ÷ $2,875.
The stop worked exactly as written and the loss was nineteen times the one it was written to prevent. The instruction was about a level; the fill was about the next available price.
Check yourself
You hold 120,000 units of a pair bought at 1.2040 with $3,600 of equity. The market gaps and your order fills at 0.9750. What is the outcome?
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Educational only. Nothing in this lesson is investment, legal or tax advice, or a recommendation to enter into any transaction. Figures are illustrative and computed from the inputs stated in the lesson.