Market Gapping
With the return of volatility to the metals markets, it is worth looking at price gaps. A market is said to have gapped in price when there is a large move up or down from the last traded price with only one new trade executed. For example if Aluminum moves from $2,500/MT to $2,550/MT on a single trade. Price gaps often occur around a news event or market disruption that causes existing bids or offers to be pulled from the market. This lack of liquidity leads to violent price moves in an extremely short space of time.
If you watch base metals prices any time Jerome Powel announces the latest FOMC interest rate decision, or when there is a new inflation or jobs figure printed in the US, markets will often have a large knee-jerk reaction where a price can move considerably up or down from the last traded price within one executed trade. It is not just macro drivers, prices also react to supply shocks such as smelter events, geopolitical announcements (sanctions), and a host of other news-based influences. Price gaps can be dangerous when it comes to hedging price risk, particularly if you are working with stops.
If the price of a commodity gaps past the level of your stop, your order will be filled at the next available level. For example, let's say you have a customer who places a stop order to buy 10 lots of copper at $9,800/MT. In usual circumstances you might expect to pay a few dollars slippage, due to order depth (as discussed in a previous post). However, if the market was hovering around $9,780 just before an inflation figure was announced, and the inflation figure beat expectations to the downside, recently the market has taken this as a bullish signal as it would increase the likelihood of rate cuts this year. The copper price could gap from $9,780 to $9,850, where your customer's stop order would be filled, not at the $9,800 level they had placed it at.
When placing orders on the LME, there is also a risk that copper in particular moves past those levels while the LME is closed. The LME trades electronically from 1AM London until 7PM London each business day. However the CME copper market trades 23 hours per business day. Announcements like the FOMC rate decisions (and subsequent press conferences) occur after 7PM London when the LME is already closed. The CME copper market is still open and reacting in real-time to these announcements. By the time the LME online platform reopens at 1AM London the following day, you will often see the LME price open significantly higher or lower from the prior close based on where the CME price has moved in the prior 6 hours. Global events also occur on weekends and bank holidays when all exchanges are closed. This can lead to extremely volatile market openings as everyone tries to react to that news at the same time.
