How to profit from the next flash crash

"In confusion there is profit"

Tony Curtis, Operation Petticoat

Looking back on 2010, probably the biggest event was the now infamous "Flash Crash" of May 6th, a mystery that still hasn't ever really been satisfactorily explained. The big question is how to protect yourself from the next Flash Crash. That one, fortunately, is easy: just don't use stop loss orders. If you have to put in some sort of stop order, make sure it's a stop limit, not a stop loss. That way, you'll be guaranteed of getting your price, though at the risk of not getting executed at all. However, as the Flash Crash of 2010 demonstrated, the risk of guaranteed execution provided by a stop loss order proved to be disastrous to many investors.

As for me, I just happened to have been out running errands that day. I didn't even know it had happened until I came back and looked at my charts. At first I thought it was just a bad tick - that happens sometimes. But then I noticed that everyone had "bad ticks". Then I read the news. Fortunately, I had no stop loss orders in so it was all pretty much a non-event for me.

But I digress. So how can we make some quick money from the next Flash Crash? Assuming there will be one, of course (and a surprising number of people think there will). Simple: just put in some limit buy orders for stocks you'd love to buy on sale at ridiculously low prices. They'll just sit there, like underwater mines, patiently waiting for some unsuspecting ship to come by and then ka-boom, you've got a bargain.

The only question is where to place your order. During the last Flash Crash, the SEC ended up busting trades that went through at over 60% price drops, so make sure you don't put in a number lower than that. No point in buying GE for a penny if the trade simply gets busted an hour later. And make sure you have enough cash around to cover the trade if it should ever happen to go off. You definitely don't want to do this on margin.

This is a low probability/low risk/potentially high reward play. At worst, you won't ever get your price, but then you're no worse off than now. Or the SEC might decide to bust 50% trades next time, but then you still don't actually lose anything.

The only real risk is in the case where a company really does drop 60% in a flash but for a good reason (the CFO is caught embezzling funds, the company goes bankrupt, etc.) Then you will have bought in at a price that's not likely to come back (although even then, stocks that fall off a cliff often have a dead cat bounce the next day, so you could still possibly at least break even). And that's relatively rare.

So the moral is to only do this with strong companies. Don't try this with drug companies that are always just one FDA ruling away from disaster, nor with airlines that face similar "sudden death" risks. Just a thought.