The US and European stock markets suffered a micro flash crash on Tuesday. Is this something that I should worry about as an investor? And will it affect FTSE 100 stocks?
What is a flash crash?
When the stock markets are open, buyers and sellers are constantly trading equities. This includes retail investors, institutional investors, and hedge funds. Nowadays this happens too quickly to comprehend, large numbers of orders take place in fractions of a second. One branch of this is known as high-frequency trading. Powerful computers make the trades, and as prices fluctuate, they’re actioned depending on pre-determined instructions and market conditions. A flash crash is when prices dip exponentially low for a short period.
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How does a flash crash happen?
A discrepancy in high-frequency computer trading leads to a sudden influx of sell orders, which rapidly magnifies price drops causing a flash crash. As the prices dramatically decline, they trigger further stop losses and the situation escalates until buy orders are triggered and the situation reverses. It’s a flash crash rather than a regular stock market crash if the market recovers within several minutes.
Many traders use margin, which means they borrow money to trade, similar to a bank overdraft. The broker has algorithms set up that flag any major losses, automatically closing trades. This is the sort of situation that can exacerbate a flash crash. So, for long-term investors, the occurrence of a flash crash is less of an issue than it can be for day traders.
That’s because long-term investors are much less likely to be trading on margin. Plus, investing for the future means choosing quality companies that stand the test of time. All shares experience some level of volatility, but by focusing on investing in companies with a solid business model and competitive outlook, wealth accumulation is more likely.
The micro flash crash this week is being blamed for an index-wide drop felt across financial markets globally. This included the FTSE 100. It happened around midday in Europe and simultaneously affected the Wall Street futures market in New York. Nevertheless, this is not something I’d worry about as a long-term investor.
A FTSE 100 stock for the future
For instance, a FTSE 100 stock I’m happy to hold in my Stocks and Shares ISA through a market crash is Unilever (LSE:ULVR). That’s because it’s been established for 92 years. It manufactures many household brands, and I think it will continue to stand the test of time. The Unilever share price has been subject to extreme volatility over the past five years. And it’s declined over 13% since October. Earnings per share are 185p, it has a 3.5% dividend yield, and its price-to-earnings ratio is 22.
The company did surprisingly well last year as the pandemic increased grocery and FMCG shopping budgets. Thus, it sees value in rewarding shareholders by starting a €3bn share buyback programme this month.
In emerging markets, particularly China and India, Unilever has been performing strongly, but Europe and Southeast Asia are still being hurt by Covid-19. And with the situation in India worsening, progress there might not be so good in the months to come.
The pandemic continues to pose a challenge, but overall, I think Unilever is positioned for long-term growth. It’ the kind of long-lasting company for which flash crashes are an irrelevance.