Cable Capitulation: GBPUSD drops 800 pips

Wow! What happened? The morning of 7th October 2016 at 00:07 UK time GBPUSD was trading at 1.2601. Over the next few seconds the 1.2600 level broke and mass selling kicked in. Sell orders triggered sell orders. Algorithms perhaps? The loop continued. GBPUSD dropped fast… really fast! “One-twenty-five figure [1.2500 GBPUSD] just got taken out!” shouts one of the Dealers here on London’s 24hr trading floor at LCG. “More selling coming in! One-twenty-four… three… one. Straight through ONE-TWENTY!!! ” Within minutes GBPUSD printed 1.1800, very ouch! “Everyone chill-out, take a step back, breeeeath. Okay what’s the damage? 800 pip drop! Oh dear! [actually another word was used]” Then reality kicked in. GBPUSD started to rally. Over the next 10mins we saw a retracement to 1.2350… calm returned.

So what caused the initial sell off? We don’t know for sure. Part of the issue could be due to the lack of liquidity in Asian Pacific FX at certain times. But theories are a fat finger erroneous order (the term used for a trader pressing the wrong button when executing an order) or a large algorithmic trade.

Foreign Exchange is not exchange-traded so it is difficult to establish a precise low. But some brokers report the GBPUSD falling to levels approaching 1.1200

Why did it drop so much? Algorithms (“algos” for short) are designed to act without emotion or thinking based on specific rules written by coders. E.g. “If GBPUSD drops more than 10pips in under a second then sell £1M.” The problem is these algos often trigger other algos which trigger more algos… and so on. These algos react seriously fast. Within a few milliseconds or even microseconds. A human doesn’t have time to intervene to stop it. By the time you’ve blinked (300 milliseconds) the algo has sold, reloaded and sold again… 20 times! Now you’ve seen it, thought about it and reacted another second has passed. In this time 500 more algos have triggered, each jumping on the bandwagon and selling more.

Back to GPBUSD… currently at 1.2380 (at time of writing this). Is this the bottom? Remember in Wednesdays article I told you the 1985 low was 1.0520. Well it’s getting closer, fast. Has GBP dropped too much in only a week?

by Ipek Ozkardeskaya of LCG

Sterling shocked the markets on the 7th October 2016 by falling sharply 6% against the dollar. Since then, the pound has recovered slightly from its flash crash but is still down against the euro and other currencies. The currency has been under a lot of pressure on fears that the United Kingdom could experience a ‘hard’ Brexit and practically lose access to the European single markets when it leaves the European Union – which could shock the local economy.

The pound fell to $1.18 in a matter of minutes, hitting a 31-year low at one point, before recovering to $1.24.

The high level of automation on which most interbank and institutional trading in London now depends on means that the speeds of dealing are now reaching ever-swift execution. At times of market turbulence, such as the uncertainty which Britain finds itself as it tries to untangle itself from the EU could mean that algorithmic trading in the City could have led to the ‘flash crash’ in the value of Sterling.

It appears that a rogue algorithm triggered the selloff after the software picked up a news report with commentary by the French President, Francois Hollande, who stated that ‘if Theresa May and co want hard Brexit, they will get hard Brexit’. This led to a kneejerk reaction from automated systems following the desperate words of a European socialist who cannot live without Britain’s sponsorship. For those with available capital, a fantastic opportunity which will never be repeated is now presenting itself.

Whatever pain occurs will be mutual, that is the inevitable consequence of 43 years of economic integration. It would seem that these politicians are not concerned with serving the electorates who pay them their salaries. Perhaps the French and German voters will take notice in the coming months before the elections in those countries.

It will be mutual in the sense that it will harm both sides economically but not equally. The UK economy will pay a significantly higher price which is why the £ has fallen sharply against the Euro. The decision to leave the EU was based on politics and not economics. The Tories pronouncements on Brexit has all been political and not economic. You shouldn’t be surprised if the EU’s response is also largely political – based on preserving the EU – and not entirely economic.

Holland is so irresponsible and some in the city and across the pond are blaming him for the flash crash. To threaten countries with punishment is dangerous talk and he and the EU should know better. I fear that the EU have lost total control of themselves. They’re basically declaring war through trade.