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Stop-Loss Orders and Price Cascades in Currency Markets


Carol L. Osler


Brandeis University - International Business School

July 2002

FRB of New York Staff Report No. 150

Abstract:     
In this paper, I provide evidence that currency stop-loss orders contribute to rapid, self-reinforcing price movements, or price cascades. Stop-loss orders, which instruct a dealer to buy (sell) a certain amount of currency at the market rate once the rate has risen (fallen) to a prespecified level, generate positive-feedback trading. Theoretical research on the 1987 stock market crash suggests that such trading can cause price discontinuities, which would manifest themselves as price cascades.

My analysis of high-frequency exchange rates offers three main results that provide empirical support for the hypothesis that stop-loss orders contribute to price cascades: (1) Exchange rate trends are unusually rapid when rates reach exchange rate levels at which stop-loss order have been documented to cluster. (2) The response to stop-loss orders is larger than the response to take-profit orders, which generate negative-feedback trading and are therefore unlikely to contribute to price cascades. (3) The response to stop-loss orders lasts longer than the response to take-profit orders. Most results are statistically significant for hours, although not for days. Together, these results indicate that stop-loss orders propagate trends and are sometimes triggered in waves, contributing to price cascades. Stop-loss propagated price cascades may help explain the well-known fat tails of the distribution of exchange rate returns, or equivalently the high frequency of large exchange rate moves. The paper also provides evidence that exchange rates respond to noninformative order flow.

Number of Pages in PDF File: 44

Keywords: stop-loss, exchange rates, currency markets, high-frequency, portfolio insurance, order flow

JEL Classification: F1, G3

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Date posted: July 31, 2006  

Suggested Citation

Osler, Carol L., Stop-Loss Orders and Price Cascades in Currency Markets (July 2002). FRB of New York Staff Report No. 150. Available at SSRN: http://ssrn.com/abstract=920687 or http://dx.doi.org/10.2139/ssrn.920687

Contact Information

Carol L. Osler (Contact Author)
Brandeis University - International Business School ( email )
Mailstop 32
Waltham, MA 02454-9110
United States
781-736-4826 (Phone)
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