Inexperienced traders and electronic trading systems helped caused the pound’s ‘flash crash’

The pound’s “flash crash” in October — when sterling lost 9% of its value in the space of a few minutes — was the result of a perfect storm of different factors, according to a new report from the Bank of International Settlements.

The BIS investigated the crash over several months, and found that no one thing can be blamed for the crash, suggesting that electronic trading systems, the time of day, and inexperienced traders can all be seen as partially to blame.

Here’s the key quote from the report:

“The presence, outside the currency’s core time zone, of staff less experienced in trading sterling, with lower risk limits and risk appetite, and with less expertise in the suitability of particular algorithms for the prevailing market conditions, appears to have further amplified the movement. Other factors such as ‘fat finger’ errors and potential market abuse cannot be ruled out, but there are little, if any, hard data to substantiate them.”

And here’s the BIS chart:

BIS pound flash crash

BIS splits the crash, or “event” into three distinct sections, as follows:

  1. Just after midnight trading volumes in sterling “picked up sharply and sterling began to depreciate against other currencies.” It fell 0.85% in 8 seconds.
  2. At 12.07 a.m. BST the Chicago Mercantile Exchange “triggered its velocity logic mechanism, which pauses trading for 10 seconds on the futures exchange, in response to the large moves in the preceding two seconds. At this point, bid-offer spreads in the spot market widened significantly.” Sterling fell from $1.24 to $1.22 and the pace of the drops accelerated. Within 30 seconds sterling was down to $1.20.
  3. By 12.20 a.m. the crash was almost over, and “prices in both the futures and spot market had settled around 2.2% lower against the dollar than their levels immediately prior to the event.”

“This combination of new participants, changes in market-making and the advance of technology raises important questions about the evolving nature of liquidity and resilience in financial markets — and the possible impact on the real economy — that policymakers should address,” BIS report concludes.

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