Possibility of Reverse Flash Crash

Recently the price of Ether on GDAX fell from ~$320 to 10 cents and then sprang back up to >$300 in a matter of seconds.

I want to look at the possibility that we may soon see a flash crash in reverse i.e., a sudden spike in the price of Ether and how placing high limit sells could be a good strategy.

So why did we get a flash crash?

Someone placed a multimillion dollar sale of Ether on GDAX at a time when there was thin demand. This ate up buy orders down to the low 200s which set off a domino effect of

  1. stop loss orders getting triggered

and…

2) margin longs getting liquidated

Both of which further dropped the price setting off yet more stop losses and liquidations etc all the way down to 10 cents.

Now what if the opposite is possible: a sudden spike in price due to a chain reaction of stop buy orders, shorts getting liquidated, and momentum bots buying in? I think we may be entering ripe market conditions for such a thing to happen.

Arguably, the underlying cause of the flash crash is that we had a fast upward-moving bull market that entered a sideways/bear stretch. This meant that the market had thin buy support and was chock full of:

1. Folks who had made quick, dramatic gains but were now afraid of losing them so they had placed stop loss orders to protect their gains.

2. Folks who were overleveraged i.e., they had bought long when the price was moving up but were suddenly inching closer to liquidation.

There were other factors like that GDAX had just introduced higher leverage for margin trading and that someone happened to place a giant sale, but I see the above as the root cause.

Right now we may be moving toward a market that has the opposite set of the conditions that led to the flash crash and we *could* see a flash spike.

Looking at depth charts (yes these can be deceiving) sell walls are thinning out. Recent market conditions have probably turned a lot of traders short-term bearish while still long-term bullish. I think there are a lot of ‘fair-weather’ hodlers who have sold have sold at least a portion of their Ether in hopes of getting back in at a lower price. But they also recognize that the price could turn on a dime so they’ve likely placed stop buy orders (buys that trigger if the price rises to a specified amount). Meanwhile the recent market has attracted more shorters who think the price will drop further.

If Ether continues to rebound (or drops more and then rebounds again), FOMO will rev up more and more and traders will continue to place stop buys at critical levels like 300 etc. Meanwhile, the price will inch closer to the liquidation point for traders who have been shorting on the way down. So a single massive buy could set in motion a cascade of stop buys, short liquidations, and bot buys that could send the price soaring.

Of course, this is all very speculative, but part of trading is imagining possibilities that are non-obvious since consensus is already priced into the market to some degree. The folks who imagined a flash crash on GDAX for example benefited enormously.

So given the possibility of a flash spike my current strategy is to:

  1. Avoid placing stop buy orders, at least ones without limits, because in the same way that folks who placed stop loss orders at $200 might have sold at 10 cents during the flash crash, if there’s a flash spike, a buy could get filled much higher than intended
  2. Avoid shorting
  3. And here’s the fun part… Place limit sells at seemingly crazy prices in case we see a major flash spike, like up into the thousands. I’m only doing so with a portion of my holdings as it’s risky (in the same way that placing buy orders at $20 before the flash crash would have been risky — it just happened to work).

In terms of where/when this will most likely happen… if this mini recovery we’re seeing right now continues, conditions could be ripe for this very soon. However, I think it will be more likely plus a potentially bigger spike if the bearish market wares on and then rebounds later on, as there will be more suppressed buy energy at that point.

And where? I’d look for an exchange that has thin sell walls, offers a lot of leverage for shorts, ideally accepts fiat deposits, and has minimal precautions in place to stagger massive buys/sales.