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Yesterday BTC-E traders were stung by yet another margin call cascade which occurred on the Russian based Bitcoin Exchange. Prices swung wildly between USD$280 and USD$150 in the space of two minutes with around 2000 Bitcoins changing hands in this short period.

Prices quickly returned to within USD$10 of where they started but this price movement is vividly illustrated in the 1 minute candle chart below.

How does this happen I hear you gasp as you rush to get your hands on some half price Bitcoin. Firstly we need to understand what a margin call actually is. Investopedia defines a margin call by writing:

You would receive a margin call from a broker if one or more of the securities you had bought (with borrowed money) decreased in value past a certain point. You would be forced either to deposit more money in the account or to sell off some of your assets.

With digital exchanges traders can configure bots to automatically manage their trading portfolios and some exchanges even have built in tools to varying degrees. For example, you could instruct your bot to close your long at market rate if the price dips below 10% of what you purchased them for. This is a great protection system that if operated correctly can protect your assets from losing too much value if a price crash were to happen while you were away from the computer.

What has happened in this instance is that automated margin calls have caused a cascade of closing long positions. You could imagine that if the price were to drop by 10% and one persons small long position is closed, its probably not going to move the price by very much. However if a large long is set to sell on a margin call it is possible swing the price by a few percentage points depending on the depth of the order book. This is because margin calls take place instantly at market price. Meaning that if my margin call executes and its for 200 bitcoin, it will fill the top 200 Bitcoin worth of buy orders on the order books until it is complete. On a relatively low volume exchange like BTC-E, 200 bitcoin if sold instantly, could easily be enough to trigger other traders automated margin calls and they also instantly sell off at market rate. If this vicious cycle crosses a tipping point it can run away on it self until all the pending margin calls are executed and the price as seen yesterday can swing wildly down as the order book wanes.

Unfortunately (or fortunately depending on your opinion) this event doesn’t happen particularly often and they are fleeting opportunities. That said, this is at least the second margin call cascade I have seen on BTC-E within the last 12 months. You can see the previous margin call cascade on the following 1 day candle chart as indicated by the red arrow, with the blue arrow representing yesterdays one.

In both instances, trading prices dropped by over USD$100 within minutes and swiftly rebounded.

These events occur very quickly and are not realistically able to be manually capitalised on. The only real way to get in on the action is to have some spare capital waiting on BTC-E, guess the level at which the next margin call will possibly drop to and have some orders waiting to be filled at that level (or slightly above) hoping to strike it lucky when it does hit. I’ve definitely thought about doing this myself, but haven’t acted on this concept due to not having a lot of faith in BTC-E as an exchange. Bitcoin Exchange Guide rates them last equal on their list of reviewed bitcoin exchanges with only a B+ rating. The biggest concern being that the owner operators of BTC-E are anonymous which doesn’t instil a lot of faith when they’re asking you to trust them with potentially thousands of your hard earned dollars.

Margin call cascades have occurred on other exchanges, but most of them have since implemented methods to prevent this having such dramatic effects. The issue as stated before is that the sell orders are executed instantly which means the order book doesn’t have enough time to refill and the price keeps slipping causing a run away cascade. Most other exchanges have implemented a stutter effect which means that if it detects a margin call cascade beginning to occur, it will space out the orders slightly instead of instantly executing. This gives other trading bots the milliseconds needed to place their buy orders and fill the gaps in the order book. Just as people have margin calls to close longs programmed into their bots, others will have the opposite. So they will be in a short position and instruct their bot to enter long if the price slips by for example 10% so they can try to buy the dip. If the stutter is in effect, then the bots tend to largely cancel each other out and this cascade situation is avoided.

Quite why BTC-E hasn’t implemented a fail safe like the other exchanges is anyone’s guess. All I know is that USD$2.4million was lost or gained in the space of 2 minutes yesterday and some people are laughing all the way to the bank.