A flash crash can feel like riding in a plane that undergoes a severe altitude drop. It’s a visceral sensation that can range anywhere from terror to sheer panic.

When it comes to the markets, the sensation of a sudden altitude drop might be the closest to describe what it feels like to experience a flash crash. Imagine your asset values plunging, suddenly and unexpectedly. It’s too fast to trade out of, and there may not even be enough liquidity in the markets to do so.

So, what might you do? The quick answer is that you might not want to do much at first. If your position is too large or overleveraged, then hopefully you had a “Plan B” before you entered the trade. But if your position is small and manageable, then you might find potential opportunities to scale into an even larger position if your asset is truly “oversold.” If not, then just sit tight.

The Anatomy of a Flash Crash

A flash crash is a sudden and steep drop in asset prices. The drop is amplified by an immense degree of selling amid a gap in buy orders or buy order withdrawals. In short, there’s a massive amount of sellers and virtually no buyers.

A flash crash may be triggered by news. It can be triggered by a major fundamental event, such as a currency pegging or decoupling. It can also be triggered by a technical glitch or human error.

In most cases, assets undergoing a flash crash tend to recoup most or all of their value within a matter of minutes; sometimes days. In the case of fundamentally-driven events, recovery is less certain.

The Reasons Behind a Flash Crash Aren’t Always Transparent

The factors driving a flash crash can’t always be pinned down. In some cases, they remain inexplicable.

For instance, the cause behind the 2010 stock market flash crash is still debatable. The same can be said for other major flash crashes in 2013 (Nasdaq), 2014 (bonds), 2015 (CHF), 2016 (NYSE), 2016 (GBP), 2017 (Ethereum), and 2019 (JPY).

But here’s something to think about: What causes a flash crash may not be as relevant as the preparations you take beforehand and the actions you take during and after the crash.

Surviving a Flash Crash

Here are a few tips to help you survive and possibly take advantage of a flash crash.

• Never trade a position large enough to wipe out your account should any type of crash take place.
• Always use a stop loss when entering a position.
• Never panic when assets undergo a sudden and inexplicable drop.
• Check the news to determine whether the cause of the drop was due to a fundamental event, technical glitch, human error, or whether its cause remains unknown.
• If you believe the move is an exaggerated reaction and one that may recoup its lost value, then you may choose to sit tight or manage your position.
• If the move was due to a longer-term fundamental factor (such as a currency peg), then you may need to revise your current strategy, whether that means reducing (or exiting) your position or finding market opportunities elsewhere.

The Takeaway

Flash crashes are almost always a shock to the system. Should you be unfortunate enough to experience one, don’t panic, seek data to better assess the situation, determine if the drop in value may potentially recoup itself, and rebalance or stay put according to your assessment and risk tolerance.