Pound Sterling Falls! These are the Developing Theories

Pound Sterling Falls! These are the Developing Theories

Last Friday (10/07/2016), the pound dropped very sharply, weakening against the USD from the 1.2 range to 1.18 in just two minutes – a very unusual sharp movement. The ordinary market calls this event ” flash crash”.

The incident occurred around six o’clock in the morning when West Indonesia, precisely around 06.07 WIB. In about 60 seconds, GBPUSD moved from 1.26 to around 1203. Based on data from Reuters, at 06.09 WIB the GBPUSD managed to touch the 1.1819 level. Thirty minutes after that, the GBPUSD managed to recover to the 1.24s range and stayed in that range until this writing was made.

What exactly happened?

Many theories developed but until the time this article was written there were no conclusions that could be made about what caused the pound to lay down like that. There are several theories that might be the possible causes of these events, including the ones described below.

Theory # 1: Due to “fat-finger” syndrome

“Fat-finger” is a term used when an error occurs due to incorrect typing / inputting the number or magnitude of the transaction. Maybe this is similar to the term young people now: “typo” . Almost the same when you typed letters when chatting via WhatsApp or the like. It’s just that, this kind of typo can be very unusual. Fat-finger syndrome can also occur due to an error in the algorithm used for automatic transactions on the stock exchange.

In fat-finger mistakes , what happens is the error in entering a transaction order, whether it’s buy or sell, but the size of the transaction is too large, on the wrong stock or contract, at the wrong price, or other input errors.

The phenomenon of fat-finger never happened before, including:

  • In 2006, a trader at Mizuho Securities in Japan made a fat-finger mistake which caused the company to short-sell a stock until the company lost 40 billion yen.
  • In 2014, a stock broker in Japan mistakenly placed orders worth more than 600 billion USD in Japan’s leading stocks, including Nomura, Toyota Motors and Honda but later the transactions were canceled. If not canceled, the value of the transaction at that time would exceed the value of the Swedish economy.
  • In 2015, a junior employee at Deutsche Bank was confused when calculating the gross and net amount when processing a transaction, which caused the bank to pay a hedge fund in the United States amounting to 6 billion USD, far more than the actual amount.

In 2010 there was also a flash-crash on the Dow Jones index. Initially this was thought to be a fat-finger syndrome but after an investigation it turned out to involve an automatic trading program that was used by a trader living in the UK named Navinder Singh Sarao. He was accused of manipulating transactions with the program.

Well, for the case of pounds the other day, some economists consider it rather difficult to “accuse” that fat-finger is the culprit. If that is the case, then the market convention will agree the parties concerned will remove the price movement and remove it from the chart. But the fact is that it doesn’t happen so the possibility of fat-finger is the cause to be small.

Theory # 2: Some take the opportunity when liquidity is low

There is no evidence raised by the bearer of this theory, but if there is someone who really wants to move the market sharply, then the right time for that is a few moments after New York closes while new Hong Kong and Singapore players will sip their morning coffee. Indeed, at that time Sydney and Tokyo were already running, but Singapore was the largest foreign exchange center in the Southeast Asia region.

Theory # 3: It has something to do with the expiration of an option contract

Friday is a day when many options forex contracts expire and this can cause extreme movement if option sellers – in this case the bank – suddenly feel the need to hedge to protect themselves from a large drop in the value of a currency. Based on data from DTCC (a clearing and settlement institution), the largest group that has an expired GBPUSD option is at the 1.25 level, with notional value of USD 1.23 billion.

In other words, a sudden drop in prices below the 1.25 level could trigger option sellers to fight to sell pounds in order to protect themselves from large losses.

Theory # 4: This is because of François Hollande

François Hollande meant the current French President, who urged the European Union to “tough negotiation” with the British who were formally preparing to leave the European Union. This was reported by the Financial Times at 07.07 Hong Kong time (06.07 WIB).

However, traders who were contacted by the Financial Times made transactions exactly at seven o’clock to seven minutes and THREE SECONDS in Hong Kong, and the article about Hollande’s statement was only published at seven o’clock to seven minutes and THIRTEEN SECOND TIME in Hong Kong.

Why is it difficult to know the cause?

The currency market ( forex market ) is not a single market but a collection of many trading systems around the world that have different time zones, unlike the stock exchange where what happens can be observed in one place, as happened in cases fat-finger above. Price data providers such as Reuters or Bloomberg take different prices at different times.

Indeed, orders that are caused by fat-finger become “viral” and enlarge, especially if done by a large bank, but none – for example – hedge funds based on algorithms to be held accountable like Sarao.

What might happen?

Traders assume that this is a sign that sterling will continue to weaken.Sterling himself has been under pressure since Theresa May – British Prime Minister – led the Conservative Party. Even before the pound crash in pounds, Goldman Sachs had estimated that the pound would further weaken by 5 percent in the next three months. In other words, Goldman Sachs has estimated that GBPUSD will move down towards 1.20.

Indeed, GBPUSD has recovered to 1.24, but it is still below 1.26 which is the level before the flash crashes.

Technically, the daily chart (Daily) GBPUSD still shows that the pound is under strong bearish pressure. The 20 MA has cut below the MA 50 on the chart, which in technical analysis is called “death cross” which is a bearish indication. This reinforces the notion that the pound’s weakening is likely not to end.

Even so, oversold conditions have been seen on the technical indicators the stochastics oscillator and CCI are plotted on the same chart – even bullish indications are seen in stochastics forex indicator. Although it cannot be a reversal signal (trend reversal) but this opens the opportunity for pull-back movement .

For that reason, the long-term scenario for GBPUSD is still bearish especially if bearish signals appear in the Fibonacci resistance area 1.24769-1.28423, with the potential target in the range 1.22508-1.18853.The new GBPUSD will open a bullish opportunity if it manages to rise above 1.28423 with the target still limited in the range of 1.30684-1.34339.

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