At just after 7 minutes after hour, whether 7pm on the east coast, midnight GMT or early Friday morning in Asian trading, pound sterling plunged by more than 6%, in the span of 2 minutes although the bulk of the plunge took place in just 30 seconds: from 7:16 to 7:46, when the market became "disorderly" in technical parlance, or in simple terms, broke. And since earlier today the Bank of England mandated none other than the BIS (specifically the bank's "Head of Foreign Exchange & Gold", Benoit Gilson) to explain what happened, here is a place to start trying to reverse engineer the latest flash crash.
For the best forensic analysis piecing together what happened last night, we go to Citi's Daniel Randall who tells the overnight story of the GBP, who also shows that the key pair involved in the selling was indeed cable...
not EURGBP as some have speculated.
As Randall points out, while GBP interbank volumes when Cable sold off to below 1.20 overnight were comparable to those of the BoE rate decision on the surprise “hold” on July 14, 2016, the big difference was that GBP sold off to a low of 1.1491 traded, moving almost 10%, when it “only” moved 2% on the July, 14. What were the key liquidity traits seen?
Price difference between GBPUSD trades in the primary market is usually 1 to 2 pips, however overnight, we saw this spike to over 50 pips up to over 600 pips.
This means that individual trades were over 50 pips apart, e.g. 1.2500 given, then 1.2450 given as the next trade, with there being vacuums of liquidity in between.
This was driven by the very large bid/offer spread in the interbank market at the time.
The below chart shows trade price differences as well as primary market bid/offer spread which blew out to 10 big figures maximum
The chart underneath gives high resolution around the move, which occurred over 50 seconds.
The first 10 seconds of the move we have smaller quick price moves lower but after this we see the primary market go two big figures wide.
As Citi points out, we have seen this on several occasions in the past, think August 24, 2015, and "could be associated with the high frequency market making interest leaving the primary market."
Not could, is.
Net flows we saw during this time period were also important and were similar as seen during the USDZAR move in January and also on the pre-referendum overnight two big figure spike in GBPUSD. While the market was still “intact” as per the chart above, we saw a large retail net selling flow, which is probably associated with stop losses. Unfortunately, it would appear that these continue stopping out, no matter what the rate, which can create large volatility when two-way prices are no longer intact as shown in the red circle above.
As a whole, whilst retail were net sellers, we net overall buying interest of GBP, mainly from the leveraged segment.
As Citi concludes:
"as we can see, execution technique is key, blunt aggression into the market can cause large impact, but if one spaces out orders and treats liquidity appropriately, then one can achieve a reasonable execution."
Translation: stay the hell out of the FX market, and just wait for more such flash crashes to occur, either buying at the trough when the algo selling is exhausted, or shorting/selling at the top, then quickly take profits, rinse and repeat. As an earlier chart from Citi showed, you will have numerous opportunities in the months ahead to do just that.