What are flash crashes in currencies and how to capitalize on them
May 6th, 2010. It had been little more than a year since the vicious bear market of 2007-2009 had hit bottom. With government stimulus programs taking root, the previous 12 months were some of the best for traders in the history of the New York Stock Exchange.
The index opened at 10,800 that day. It was still several thousand points off the market’s all-time high, but more than 60% higher than its miserable low just a year before. As the day unfolded, however, things weren’t going well.
Concerns about the Greek sovereign debt crisis had the market down about 300 points – not the best day, to be sure. At around 2:42 pm, things took a sharp turn for the worse, as the market suddenly nosedive not seen since the brutal days of September 2008.
In the blink of an eye, more than a trillion dollars of market value vanished. Nobody knew what was going on. No banks had failed, there were no reports of massive job losses, dismal Q1 earnings, or major developments in Greece.
Then, just as quickly, the market shot back up to where its position half-hour earlier. Traders on the New York Stock Exchange had just lived through the first ‘flash crash’ in history. After years of investigation, high-frequency trader Navinder Singh Sarao was brought up on criminal charges in 2015.
From his home office in London, he had shorted thousands of E-mini S&P 500 futures contracts using spoofing algorithms (illegal per NYSE rules). However, he neglected to cancel these orders. That set up a situation where his automated program looped 19,000 times before he stopped it.
While Mr. Sarao received blame for the first-ever flash crash, his abuse of high-frequency trading was not its root cause. In this post, we’ll dive deep into what causes flash crashes. Plus, how you can pounce on them to make a tidy profit.
Flash crashes – a feature of 21st-century stock trading
In short, a flash crash is a steep fall in stock or currency prices that reverses itself within minutes. These events only started occurring in the past decade. Just as computers replaced humans as the chief executor of trades on stock markets.
While these events last no longer than 10-30 minutes, they can have severe impacts on the bottom lines of companies and traders. For instance, those who set stop-loss orders can lose thousands of dollars when they would have been fine had a flash crash not occurred.
After the events of May 6th, 2010, the taken steps aimed to reduce the probability of future flash crashes. Despite the efforts of regulators, four high-profile flash crashes have since rocked various markets around the world.
While automated trading triggered the first flash crash, the second one happened due to a different 21st-century threat: hackers. On April 23rd, 2013, cybercriminals compromised the Twitter account of the Associated Press. They quickly used it to tweet an erroneous report of a terrorist attack at the White House. This caused the loss of $136 billion on the S&P 500 before markets recovered. Although these sell orders were executed based on ‘fake news’, all trades were considered final by officials.
Currency markets have also experienced their fair share of tech-driven market chaos. The first major instance of this was triggered by a lack of foresight by the Swiss National Bank – after abandoning the CHF/EUR currency peg in January 2015, markets bought up Swiss francs en masse, pushing down the value of EUR against CHF.
This resulted in a 2015 H1 loss of USD 51.7 billion, as the Swiss National Bank was buying up Euros to maintain the 1.20CHF/1 EUR peg before January 2015. When news of this hit the markets on July 31st, 2015, CHF plunged 0.4% against EUR before quickly recovering.
The most recent currency flash crash occurred in the opening days of 2019. On January 2nd, while most traders were still nursing hangovers, Apple CEO Tim Cook revised Q1 revenue forecasts downward, mostly due to weak sales in China.
With low liquidity in the market, this sudden bad news hit equity markets like a hammer, triggering huge losses on a large APPL long position. Once news of this drop reached currency markets, traders fled the USD for the perceived safety of JPY – this drove the USD/JPY pairing down by more than 4% within a few minutes.
Harnessing the sudden violence of flash crashes for profit
Money does not only come in when prices go up – there’s a potential profit when markets fall, too. Warren Buffett once said, “Be fearful when others are greedy and greedy when others are fearful”. This same logic applies when markets flash crash.
Don’t rely on your senses, though, or you’ll be likely to miss out on the action. To execute trades when the market is (very temporarily) in your favor, you’ll want to set a limit order. This tells your trading program to buy a currency when the pairing hits a certain price – say, 1.36 for USD/CAD.
But what if you aren’t a day trader? If you move currencies regularly and want to grab some at the favorable rates that flash crashes provide, find a money transfer company that offers limit orders. For instance, OFX allows clients to place limit orders on transfers over AUD 30,000. These can be left open overnight – if the indicated price is hit, the order is filled.
To the quickest trader goes the spoils
Trying to catch a flash crash is like trying to take a picture of a rare bird. It might be gone before you manage to get your phone out.
Don’t rely on your ‘cat-like reflexes’. By setting a limit order below the expected range of a currency pairing, you’ll be able to get a fantastic deal while everyone else misses out.