Do not invest more money than you can afford to lose.
The ‘flash crash’ of the British pound (GBP) in early October 2016 was caused by several factors that together contributed to the unexpected movement of the currency, according to a report made by the Bank for International Settlements (BIS) in collaboration with the Bank of England, which was published over the weekend. One factor that played significant role was the time of day (early Asian trading time).
The “flash crash” happened shortly after midnight London time on 7 October, when within a couple of minutes the GBP crashed by about 9% against the USD, reaching a historical 31-year low. The pound quickly retracted much of the move, but left the markets in shock. The exact cause of the event was not clear, but there were several scenarios that were said to have triggered it.
“This analysis points to a confluence of factors catalysing the move, rather than to a single clear driver. Furthermore, it concludes that the time of day played a significant role in increasing the sterling foreign exchange market’s vulnerability to imbalances in order flow,” according to the report.
The BIS and Bank of England report indicated there were three distinct phases of the flash event that later led to gradual recovery in market liquidity:
- the early phase of the move, during which sterling depreciated rapidly from 1.26 to around 1.24 against the dollar in response to significant selling flow, but in an orderly fashion and with broad participation on key venues
- a period of a number of minutes of extreme dysfunction during which sterling fell further, rebounded and then traded in a wide range
- lower volumes and narrower participation, pointing to a greater role for the actions of individual market participants as a driver of the sharp moves.
In addition to the time of day, other factors that “contributed to and amplified this market dysfunction” included significant demand to sell sterling to hedge options positions as the currency depreciated; the execution of stop-loss orders and the closing-out of positions as the currency traded through key levels; the presence of staff less experienced in trading sterling, with lower risk limits and risk appetite. The report also suggested the fat finger (an error by a broker or a dealer in entering a trade using a wrong rate or volume) and potential market abuse could also have contributed to the sudden GBP movement, but there is no hard evidence to substantiate them. All these factors resulted in lower market liquidity which further encouraged withdrawal of liquidity by providers. Meanwhile, a media report released shortly after the move began is only likely to have added marginal weight to the move as it did not contain new information.
According to the report, the GBP ‘flash crash’ from October 2016 is not a new phenomenon. There are many other such events in history. The fact that financial institutions incurred material financial losses from the GBP ‘flash crash’ is a good indicator that shows market participants having learnt lessons from similar past events.
Switzerland-based BIS, set up in 1930, is the world’s oldest international financial organization, with 60 member central banks, representing countries from around the world that together make up about 95% of world GDP.
To see BIS’ report, follow this link.
