There are several compound factors why ETFs crash:
1) Leverage
2) Real-time re-pricing
3) Stop loss orders
4) Exchange "Circuit Breakers"
The first reason is obvious. ETFs have made it easy for home gamers to add 3x leverage to their portfolios across almost every asset class. In oil for example, this means that the tail is wagging the dog and leveraged speculators are in control of the market. That momentum cuts both ways.
Secondly real-time pricing. Mutual Funds only take in new money at the end of the day based upon settled stock prices. This eliminates the possibility that the Mutual Fund Net Asset Value will get out of whack with the underlying stocks. ETFs however, re-price in real-time. What happens in a crash scenario is that the algos that control ETFs can't keep up with the sell orders, which opens up the potential for chasmic divergences between NAV and underlying.
Stop loss orders further exacerbate the problem because many people keep these orders in place at all times. So what happened on August 24th, is that the ETFs gapped down at the open, they hit a barrage of stop loss orders which further pounded them lower, far below underlying value. Then, when the funds started to recover, the exchange circuit breakers kicked in on the UPSIDE and prevented the ETFs from re-converging with underlying value. In the event, this caused more sell orders and put more downward pressure on the ETFs. In some cases it took hours for the ETFs to clear the circuit breakers which halt trading at pre-set % intervals.
What has been done to fix all of this?
Let's go ALL IN and find out...
