All the who's why's and wherefore's and still no one knows
My phone was on the verge of melting when I woke up this morning. Trust me to pick the one time I have an early night. Thankfully I put the blower on silent.
For all the possible explanations that have been given, and they could all be valid, the chatter now seems to have settled on the algos and electronic trading as the main reason behind it. It might have been a perfect storm situation where different small parts came together to make one big crash. The Hollande news could have been a small trigger that caused algos to go selling in thin liquidity, hitting the barriers and stops nearby, all of it weighed further by massively negative sentiment already in place. It might have been a fat finger. I spoke to some of my mates on trading desks and none of them had any better ideas than what we've already heard.
For all the grasping of reasons, we can't change what has happened and our reasons for trying to understand what happened are largely irrelevant. This comment earlier from reader Peter sums it up best;
"We've had a good demonstration of psychology-at-work today. First we had the shock, the big unexpected crash. It didn't take very long really. Ever since we've seen people scrambling to make sense of it. That, unfortunately, will keep going on for some time.
Humans being what they are, experience cognitive dissonance (uncomfortable confusion if you like) when a shocking event cannot be explained or understood. This triggers a search for an explanation, a way to make sense of things. If a plausible enough story (or narrative to use Eamonn's big word) can be found it will be latched onto as a way of relieving the discomfort. Once this has been achieved, the story takes on importance (since it now has value) and after a short while of groping about in search of a better story (one likely to be even more satisfying or comforting) it will tend to grow in credibility and be believed with mounting conviction.
Enter the story tellers. We have the financial media, spokespersons from financial firms with relevant-sounding job titles, and a litany of others. A fairly short list of "usual suspects" will appear and be put forward (illiquid time of day, fat finger, news, etc) and some will try to put the pieces together in some way to make a satisfying or modestly plausible explanation. Eamonn did a good job of documenting -- and even engaging in -- this process today.
One remarkable observation that can be made is that none of them really have an understanding of exactly how the event could be setup and executed. They don't actually know what happened. This doesn't seem to matter. It is about finding something and latching onto it.
In a sense, what is far scarier than the crash, is that so many people who purport to know so much about the forex markets, actually know so little and gladly grab the most superficial ideas. But this is just dissonance at work. Even the hot shots from banks and brokerage firms have to find something to deal with it. And because it really isn't satisfying to them or anyone else we will get the story repeated over and over ad nauseam."
Still, it is a good exercise to understand the mechanics of what happened, and they are pretty simple.
Something/someone hit the sell button, whether on a big order or not, whether it was a big amount or not. That caused an avalanche because the conditions were such that the sells triggered, overcame the bids in the market. If there is a lack of liquidity, electronic/automated trading platforms don't have the human ability to stop and say "wait a moment, the market's a bit thin, I'll hold back my sell orders until I see some bids entering, so I can get a better fill", they simply keep selling, selling, selling, and if there's nothing in the way, the price drops until they hit bids that are. If those bids aren't there, or are not enough, the price keeps going down, and it snowballs, because there's stops that are hit and now they are looking for bids too, and they add to the sell orders that are already scrabbling for bids.
All that keeps going until finally someone or something in the market steps in and stops it, either by finally hitting bids that soak up all the sellers or big trading desks starts scaling in massive bids because they smell a killing, because the pound has just collapsed on naff all.
The real big clue that this was a crash of that type is that if there was real news behind it, we'd still be trading at the lows or lower.
What happens from here is anyone's guess but a lot of longer-term shorts would have just been given a lottery win and some have probably cashed out. That may balance the market for a bit but then we'll obviously have chasers coming in today and jumping on shorts, and thus we see the pound under more pressure.
Nothing has changed in the world of Brexit, the UK and Europe but that doesn't mean the price should go back to 1.26. It was falling before then for a reason and got tipped over the edge. The pressure pot has blown and that might settle things for a while, or it might not. Until then we're in very dangerous trading conditions and you need to think about whether you need the increased risk that's been thrown into trading the pound right now. I certainly don't so I'm kicking back and watching the show.
And as for further speculation on what happened, I'll let QOTSA give you the real answer.
