British Pound Flash Crash happened suddenly without warning on October 6th late night during the Asian market hours. All of a sudden within 2 minutes GBPUSD fell 1200 pips and then recovered 1000 pips in the next few minutes. British Pound was trading at $1.26 when within in less than a minute it fell to $1.14. This was a sudden 10% drop in British Pound bringing it to a 31 year low against US Dollar. In the next few minutes British Pound had recovered almost all the lost value and was trading at around $1.23.
In this post we are going to discuss in detail what happened on that day and what might have caused this flash crash. Another thing that we want to discuss is whether we could have predicted this move or not. Before we proceed, did you download this month copy of FX Trader Magazine issue? This is a good magazine that provides you with latest market analysis by renowned market experts. Let’s return to our topic of British Pound Flash Crash. First take a look at this GBPUSD H1 chart below.
In the above screenshot you can see a very big one hour candle. This is the candle that tells us the story of this flash crash. It has a very big lower shadow which indicates price fell big time and then recovered almost all the lost ground.
What Caused The Flash Crash?
Now it is very difficult to find the exact cause of this flash crash due to the decentralized nature of currency market. There is no central authority to regulate the currency market. Basically it is a over the counter market. At the top is the interbank market where big banks and other big financial institutions execute their trades through a trading terminal that is mostly provided by interdealers like Reuters and ICAP.
There are a few big interdealer brokers like ICAP and Reuters that bring big banks together and match the big buyers and sellers of currencies and commodities like gold and silver. ICAP has developed EBS Spot Trading System while Reuters has developed Reuters Dealing 3000 System that provide market making facilities to this interdealer market.
In this market volumes are big. Below this interdealer market we have the banks and the retail brokers. These retail brokers provide market making to us small traders by aggregating our orders and then off loading them in the interbank market. A slight detour to the topic, do you use pivot points in your trading? Pivot points are used by professional traders in their daily trading.There are 5 different pivot point formulas that are used. Most popular formulas are the Camarilla pivot point formula and the fibonacci pivot point formula. Did you download your FREE copy of the Fibonacci Pivot Point Indicator?
This is the most simple likely cause of the Pound Flash Crash 2016. During the Asian Market Hours when the volumes are usually very low and trading activity is not that big as compared to the London and New York Market hours a rogue algorithm placed a big sell order. British Pound was already under pressure when it opened with a huge down gap on Monday when on the weekend British Prime Minister Theresa May had said Brexit will be hard. So already market was jittery.
On Tuesday British Pound broke the support of 1.27974 that was found when actual Brexit Referendum vote outcome was announced. Before Brexit Referendum GBPUSD reached 1.50135 on the expectation of a rejection vote. But when it became clear after the Brexit referendum initial vote count that the yes vote has won, GBPUSD suddenly changed direction and headed down.
So GBPUSD found resistance there when the referendum results were announced and fell 1.32223 at the end of week. Over the next 2 weeks it lost another 5oo pips and finally found support at 1.27974. Over the next few months, GBPUSD traded above this level. Vladimir Ribakov is a great trader. Did you take a look at his sRs 2.0 hybrid trading strategy?
Did A Rogue Algorithm Cause The Flash Crash?
On the weekend before October 6th, British Prime Minister said in a public statement that Brexit proceedings are going to be hard. Market became jittery and on Monday open there was a 100+ pip down gap. On Wednesday French President Hollande talked about a hard separation of UK from EU. This statement was made a few hours before the flash crash. The most likely cause is the algorithmic trading system that picked up this news from the internet and took it as a sell signal. A few big sell orders placed by these algorithmic trading systems started the snow ball effect by triggering stop loss orders in the low volume environment. Price fell so fast that there was no buyers during the 2 minutes. This caused the big down movement.
Kathleen Brooks, the director of research at City Index, said in an email on Friday morning: “Apparently it was a rogue algorithm that triggered the sell off after it picked up comments made by the French President Francois Hollande, who said if Theresa May and co. want hard Brexit, they will get hard Brexit.
“These days some algos trade on the back of news sites, and even what is trending on social media sites such as Twitter, so a deluge of negative Brexit headlines could have led to an algo taking that as a major sell signal for GBP. Once the pound started moving lower then more technical algos could have followed suit, compounding the short, sharp, selling pressure.”
Algorithmic trading systems are also known as black boxes. These black boxes are programmed to trade on a number of scenarios. As the above comment suggests it was a twitter trading algorithm that started that snow ball. These algos trade the market sentiment picked up from social media like twitter and Facebook. When these algos found a lot of negative comments regarding the British Pound they took it as a sell signal.
Several market commentators believe that an overzealous algorithm may have been partly responsible for the overnight sterling crash. While algorithmic trading is supposed to help smooth market volatility by increasing the volume of trades, its automated nature can lead to unexpected and sizeable transactions that move markets significantly.
Could We Have Traded This Flash Crash?
British Pound was under a lot of selling pressure. It is evident when you look at the monthly and the weekly chart. A week before GBPUSD had broken the support of 1.2794 found after the Brexit actual vote and made a new low at 1.2915. This was a signal that an important support level had been broken and GBPUSD is going to fall more and more until it finds a new support. A few hours before the flash crash GBPUSD was already moving down with a lot of momentum so the charts were already giving a sell signal. We did not trade this flash crash. When we looked at the charts next morning, we found a big candle which was astonishing. GBPUSD was going down. It was clear but we thought it would go down a few hundred pips and find support there. No one was expecting a very big down move.
Hunt Volatility Funnel Also Known As HVF
Francis Hunt has developed this Hunt Volatility Funnel that is basically a modification of the triangle pattern. Watch the video below in which he explains how the down move was all written on the charts days and weeks before the flash crash.
https://www.youtube.com/watch?v=rVJb8wyoxIs
Triangle pattern is a popular breakout pattern that is used by professional traders in determining a breakout. Trading a triangle pattern requires a lot of experience. Below is another video in which Francis Hunt explains what is HVF (Hunt Volatility Funnel).
Finding the breakouts is the real thing in trading. But these breakouts need some fundamental shift in the market. Flash Crash happened on the back of negative comments made by British Prime Minister and the French President. Market was already moving down when most probably a rogue algorithm misjudged and placed a big sell order.
https://www.youtube.com/watch?v=lQruPQihupM
There were traders who were caught on the wrong side of the market during the flash crash and suffered heavily. Only way to avoid a blown account in such situations is to always follow risk management and never risk more than 1% of your account equity at any time. Another method to avoid being on the wrong side of the market is to always trade in the direction of the trend on the higher time frames of weekly and daily. The trend was strongly down on the daily and weekly so there was no point in trying to open a buy trade. Always remember this saying: Trend is your friend until it ends. So those who tried to trade counter to the trend were the ones who suffered the biggest losses. Lesson learned: never trade against a trend. These crashes do not happen all of a sudden as by now you should have understood. These crashed built on something fundamentals that are already making the market nervous. So always take the long term trend in account when opening your trade. This is another lesson that scalping is not a good strategy. Avoid it.