Back in June, there was that Ethereum Flash crash on the GDAX exchange. It was quite a thing to see, and I'd been filming a video when it happened, so I made another one talking about what may have caused it, and also discussing trading CFDs on Etoro:
The information and opinions in my videos and this article are not intended to be investment advice. Seek a duly licensed professional for investment advice.
So, firstly, the Flash Crash - why did that happen?
The so called 'Flash Crash' gets its name from the fact that the price of the asset falls very suddenly, and very sharply, and then recovers its former value just as quickly soon afterwards. Hence the "Flash' in the name, as it only lasts a very short time, comes out of nowhere and the value doesn't stay low - it goes back up again. This has happened in the regular stock markets as well - the most famous one being 'The Crash of 2:45' which happened in 2010 in the United States and only lasted 36 minutes, but during that time it decimated a lot of portfolios as people scrambled to alter their investments due to the value dropping so much. It happened again in 2015, and this time, it was largely blamed on one single trader from London using automated trading software which he'd modified to try to game the markets. This reasoning has been refuted by many other people, though, saying it's ridiculous to blame one small-time trader for the crash. They've tried to put safeguards in place so that it doesn't happen again now, but we'll see...
If you'd like to read more about it : https://en.wikipedia.org/wiki/2010_Flash_Crash
The Crash only really occurred on one crypto exchange
The price of Ethereum crashed on an exchange called GDAX, which is Coinbase's parent exchange. The price of Ethereum suddenly dropped and scared the hell out of everyone, then it suddenly jumped back up, and people were left wondering what just happened. It was blamed on one massive sell order, which then started a chain reaction of triggering people's stop losses which further drove the price downwards, triggering even more stop losses and on, and on.
Why would a 'Stop Loss' being triggered lower the price?
A Stop Loss is basically a predefined order, which you can place when you open a trade which will sell your asset if the value ever reaches a certain price. It's a way to be able to leave your computer for a while and go outside, and do other things, safe in the knowledge that if your asset ever loses too much value when you're away, the system will automatically sell it for you so that you don't lose any more money.
Supply and Demand - how price is affected
Markets work off supply and demand. As an asset becomes more widely available, its price lowers, as there are more people trying to sell it, and fewer people trying to buy it at the time. It works like that with everything - housing's the easiest example - when there are lots of houses for sale and only a few buyers, the sellers drop their prices to make their property more attractive to the buyers. When there are very few houses for sale and lots of buyers, then the property owners can raise their prices, as they know the buyers are more desperate. The same sort of thing generally holds true for all assets - when supply is greater than the demand, then the price falls.
The Ethereum supply suddenly shot up
So, a massive sell order went through - someone sold a lot of Ethereum in one go. More Ethereum was available on the market - the price dropped. As it dropped, someone's stop loss was triggered, as the price had reached their pre-specified price target. The stop loss automatically put their Ethereum up for sale. This made the supply even greater than the demand. The price dropped again. As it dropped further, another stop loss was triggered, leading to a cascade where over 800 other stop loss triggered, and the price just kept falling and falling until it was trading at $0.10 - down from approximately $319 a second before. That's an enormous drop, and a lot of people lost a lot of money. The price soon recovered, as everyone realised it was a glitch, rather than a realistic representation of Ethereum's value, and they started to buy like crazy. Some people will also have made a lot of money...
Why did the price drop on Etoro then?
Etoro derives its price for Ethereum from a number of different exchanges. Now, although the flash crash only happened on GDAX, ripples of that price fluctuation were felt on other exchanges - not anywhere near the same magnitude, but they showed up. Etoro, drawing prices for assets from a number of other exchanges, also registered the drop. Any time something like this happens, the whole market takes a bit of a pummelling, as cryptos are new, and confidence is easily swayed for now. The effects didn't last long though, with the prices soon regaining lost ground, but it was quite something to see... Imagine if we'd all bought Ethereum for 10 cents... Wow.
CFDs on Etoro
About CFDs - it used to be that all assets you traded on Etoro were CFDs -"Contracts for difference". A CFD is basically a contract tied to the value of a specific asset. So, when you buy a CFD on Apple for example, if Apple's stock goes up in value, the value of your CFD goes up - it's directly and precisely linked to the value of the underlying asset. In classical stock trading, you'd buy actual shares in a company, but with CFD trading, you buy an asset which is directly linked to the value of the stock you're interested in. You can basically make exactly the same amount of money as if you owned real shares in the company, but you don't. You can also get dividend payouts on Etoro - so they've tried to replicate the same value as you would derive in all ways if you owned the real asset. You can also use leverage with CFDs.
Leverage and CFDs
Leverage is a sort of multiplier effect. When you open a trade on a stock or any asset (not cryptos for now) on Etoro, you can choose to use leverage - the leverage available changes depending on the type of asset you're trading, and it's basically a way of borrowing money (leverage) from the broker temporarily so that you can buy more of the asset than you could if you only used your own capital. So, a $50 trade on Apple, using X10 leverage (times 10) means you're trading as though you'd bought $500 worth of Apple stock (in a CFD form). Leverage can be very useful, but also dangerous for new traders, as you can make OR LOSE money at a much faster rate than normal, and this can cause panic if you're not sure what's going on with the markets. Using leverage also means paying higher 'overnight' and 'weekend fees' in many cases, so if you're planning to hold onto an asset for a long time and watch its value slowly increase, then this is something to keep in mind. I'll explain about that later...
More and more, Etoro looks to be moving away from CFDs on its platform. Several ETFs are now the actual underlying asset on the site rather than CFDs, and this year (2017), Etoro has made all manually traded 'Buys' (when you're betting the value will go up) on cryptos the real underlying crypto rather than a CFD. For now, if you want to 'short sell' (bet the value will go down, and make money as it does so) cryptos, it's a CFD you will own, and all copy-traded crypto positions, as well as assets in the Crypto 'Copyfund' are still CFDs.
Will Etoro move away from CFDs further?
According to a marketing person at Etoro who I spoke too (I'm not sure how reliable this is though) they're planning to move away from CFDs throughout the site, and even make the stocks and shares we can trade, the real underlying assets rather than CFDs. If they can, that would open up huge new markets for them, as the United States, and some other nations banned trading in CFDs after the 2008 financial crisis, as they blamed all sorts of derivatives for the economic woes of the world. The U.K, Europe and most of the rest of the world continues to use CFDs though.