Was today the first time you’ve woken up to see the equity futures locked limit down? It’s a terrifying thing to see. Friday’s strong close probably did a pretty good job of fooling traders into believing that there were some buyers coming back into the market. Unfortunately, that just wasn’t the case.
The funny thing is, when you look at the stats, it’s hard to understand why this is as bad as it is. The economy is still running strong; last week's jobs number was great, and wages are increasing. So, what is striking fear in the hearts of traders right now?
In a word; Coronavirus. We’ve been talking about the global uncertainty surrounding the outbreak of the virus for quite a while now. After 2 months of weighing the possible outcomes, traders finally started to react, and that reaction came in the form of panic selling.
Sunday night, the e-mini S&P 500 futures gapped open lower and sold off 5% to lock limit down for the rest of the overnight session. According to the CME Group’s price limits guide, there are 4 tiers of “circuit breakers” before trading is permanently halted for the day.
- Tier 1: 5%
- Tier 2: 7%
- Tier 3: 13%
- Tier 4: 20%
Tier 1 applies only to the overnight Globex session, which occurs between 5:00pm and 8:30am central time. Tiers 1, 2 and 3 apply to regular trading hours, from 8:30am to 3:15pm central time.
Once prices trade below the 7% circuit breaker for a certain amount of time, trading will be halted for 15 minutes while price limits are extended. This process repeats for Tier 3 when prices drop below 13%. Once the market drops below the 20% level, trading will be permanently halted for the day, and the market will not re-open again until the start of the following days session.
The system of price limits in equities was put into place after the stock market crash of 1987 when the Dow Jones fell more than 22%. ‘Black Monday’, as it came to be known, still stands as the single largest 1-day drop in Dow Jones history.
The last time we saw the 7% circuit breaker trigger was at the height of the financial crisis back in 2008. Since then, we’ve only seen a 5% session break one time; the night Donald Trump was elected president. For now, this is the norm, so be aware of these areas until volatility starts to fall back a little.
Negative Interest Rates?
For months now, economists have been saying that we should see interest rates hit 0% by the end of the year. The way things are going right now though, it could be happening a lot sooner. And what comes after 0% rates? Well, that would be negative interest rates. So, what does that really mean?
It’s no secret how President Trump feels about the fed raising rates so quickly after his election. After all, we sat at 0% for the better part of 10 years during the Obama administration, then raised rates a total of 9 since 2016. Seeing how the market is reacting to recent headlines, can we say that his concerns were validated?
Even after the Fed came out with a surprise 50 basis point rate cut late last week, the president felt that fed governors still had more work to do. I personally don’t think he will be happy until rates fall below zero.
There are both good and bad scenarios that could possibly play out with negative rates. The basic tenet behind them is encouraging banks to lend more money in times of economic instability instead of incurring storage fees for holding their reserves in the central bank. This scenario benefits consumers directly in the form of low interest loans.
The counter argument is that negative rates could create a big enough squeeze on profits that banks could actually start to lend less just to curb their losses. This could possibly lead to consumers simply hoarding cash away, and not spending it until the economy begins to recover.
Since we’re still technically on an economic upswing, it’s easy to view rate cuts in the U.S. as additional economic stimulus. However, it has not been playing out that way so far.
After another round of failed negotiations, Saudi Arabia decided to cut oil prices by more than 10% in retaliation to Russia’s refusal to comply with OPEC and cut oil production. The result was crude oil’s largest price drop since 1991 when the Gulf War broke out.
At its lowest, crude oil futures were down over 30% in pre-market trading Monday morning. The same price limits that prevent equity markets from completely collapsing do not apply to crude oil. This price war could rage on for months, and speculators are starting to hear whispers of $20 a barrel, or possibly even lower, so watch out below.
Manage Your Risk
The swings continue to get wider, and the risk to trade these markets continues to increase. If you’re new to this, there’s no shame in stepping out to observe the price action, it will probably save you money.
At the same time, I get it that the profit potential is just too much to walk away from. Managing risk is going to be key until volatility starts to die down. Scaling back your size is a good way to start. Also, check out the Topstep Swing Trading Combine for low risk access to the markets. You can catch the bigger moves by staying in longer, and the micro e-mini contracts are a great tool to manage risk.