Last night while you were sleeping the British pound value plunged 6% in less than two minutes. The pound dropped to $1.18 against the USD crashing through its support levels which lead to a sharp selloff. The event created a new 31 year low for the pound after it leap past the previous three decade low.
The entire event took place over 2 minutes and 6 seconds. And changed the entire nation of Britain value by 6% in mere seconds. While the currency did eventually recover the question becomes how did this happen?
There are several scenario’s floating around to what could have caused the currency drop from a fat fingered trader, a wise trader taking advantage of low liquidity, option expiration dates, stop loss orders or the a statement by the French President Francois Hollande.
1) The first belief is that computer algorithms or fat finger trader resulted in big consequences. What most people believe happened is that a trade entered the wrong number or that a glitch in a trading algorithm resulted in the trade. This is not uncommon and occurred back in the flash crash of 2010. Usually, the trades are wiped from the records within hours as if they didn’t occur. Since this has not yet happened does make this less likely.
2) Low liquidity- If you look at the time that the trades occurred it was at an intersection of markets. New York traders had gone home for the day while the biggest markets in Asia were just drinking their coffee’s. If someone wanted to do this deliberately, this would be an ideal time. This, again, does seem unlikely, but is being talked about on the news.
3) Option expiries- Friday is the day that forex options tend to expire and can cause trading moves if the writers (banks) need to cover themselves. If you look at the option expiring last night, the majority was at 1.25 with a small amount at 1.23. What this means is that when the pound dropped below 1.25 it triggered a scramble of traders trying to sell the pound to protect themselves from losses.
4) Stop Loss orders- We have talked about this before- stop losses can cause unintended events. Stop loss can lead to unexpected trades that can drive a down day into a sharp drop. While you think a stop loss at 1.25 would sell your position at 1.25 the reality is it triggers selling as soon as it hits that level. This means you could be filled at the next buyer prices far below 1.25. Traders use stop losses to mitigate losses at pre-agreed levels when the markets move or when they are asleep like last night. It is possible that there was a large volume of stop loss orders that were executed last night.
5) The final theory is that an article by the French President on their stance of Brexit was published at 7:07am Hong Kong time. Because computer algorithms are made to find news regarding breaking stories and interpret them as negative or positive it Is possible the computer traded on the article. The publishing of the article occurred seconds after the pound started moving.
Uncovering the source of the pound’s sudden drop will be difficult as forex markets cover many trading systems and time zones with no single repository for information. As a result, it will be difficult to flag what exactly happened.