Excerpts from an excellent post from Sean (the minimalist trader)
Breaking News: Markets are risky.
Ok, you knew that. You wouldn’t be here if you weren’t already permanently scarred by a bad beat at least once in your career.
Today, a new element of risk has been introduced via market structure. The May 6th flash crash was the first headline advertisement for what surely has become a topic on every active traders’ mind. Stories proliferated around that time of traders who got blown out on that day, and investors who’s way-out-of-the-money stops were triggered, only to watch their stocks swiftly rebound to a more normal price. And even to this day, it seems at least once a week some random stock has its own mini flash crash as a result of some computer gone haywire or a cascade of triggering stop orders.
Traders and Investors are rightly concerned about this, and some are downright scared. It puts many of us in awkward positions. We all know we should trade with stops firmly in place, but in this new marketplace it seems putting a resting stop order on the books is practically an invitation for some HFT [High Frequency Trading] stop-sniffing algo to hunt it down and force its execution. So do we then just put in mental stops? Seems like a logical jump, but that method is fraught with all kinds of its own headaches: What if I’m not at my desk when the trigger is hit? How do I exit? What if I’m frozen in a panic-stricken trance? It happens. Believe me.
For all these reasons and more, this is why I trade options and why I think options trading should become a bigger part of your trading arsenal.
Options trading has always been a useful tool to express a market opinion.
I utilize them because I can define risk. This is especially important when taking speculative, risky, or news-driven positions. This is simplicity in managing risk. And this is why I like options and feel that options are an essential tool for any Minimalist Trader.
Sean’s fears are very realistic. We’ve seen the system break down, and although I’m more confident than he about it the severity – the next time it happens, there is no way to be certain.
Just one more reason for using options.