Efficient Markets?
Fat finger trades & flash crashes; these are terms that many of you might have heard on financial news channels or even seen plastered across headlines in newspapers, but do you really know what they mean?
Despite the fact that the global foreign exchange market is the most liquid market in the world and involves some of the brightest people and most sophisticated technology, errors still occur, and accidents still happen all the time. Like freak waves rising from an otherwise calm sea, these episodes might be fairly infrequent, but when they occur they can cause serious damage!
What Are Fat Finger Trades?
"Fat-finger trades" are the term given to a trade that is placed in error and the term alludes to the instance of someone accidentally hitting an extra digit on their keyboard when placing a trade. These type of errors have occurred since the beginning of electronic trading and have accounted for dramatic market shocks.
What Are Flash-Crashes?
A similar problem is that of "flash crashes" which are typically triggered by algorithmic trading programs which flood the market with orders and exacerbate sell-off. These programs, which are typically momentum based, chase the market and during times of thin liquidity can push markets to extreme lows in a matter of minutes. Below, we take a look at some famous episodes of these problems.
Famous Fat-Finger Trades & Flash Crashes
Drunk Trader Sends Oil to Eight Month Highs
In 2010 Steve Perkins, a futures trader at PVM Oil Futures, mistakenly bought 7 million barrels of crude during a late-night drinking session. The error saw Oil spike to an eight-month high, leaving markets dumbfounded. The next morning an admin clerk contact Perkins over the abnormally large trade but was unable to recall the incident. After attempting to cover his tracks with a story about trading alongside a client, Perkins was eventually forced to admit that he was unable to remember what happened after refusing to put his desk in touch with the client.
The drunken error pushed Oil up by more than $1.50 a barrel in less than 30 minutes. To put this in context, this type of acute price shift would only usually be seen in response to a significant geopolitical event and was 10 times the size of the typical quantity of oil futures traded in that timeframe. PVM eventually reversed the entire trade for a total loss of $9,763,252 which is roughly equal to the firm’s annual revenue.
So, the next time you feel like placing a trade after a few evening drinks, think again!
Gold Goes Bust
Just this week we saw Gold cratering 1% due to an alleged "fat finger trade". On Monday, Gold plummeted from $1,254 to $1,236.46 due to a huge 18,500 lot order which equates to 1.85 million ounces of gold. This is way above the typical average dealing size for Gold and markets were once again rocked as they scrambled to figure out what was behind the crash. The person behind the error is not yet known, and some traders suspect that the error wasn’t, in fact, a "fat finger" trade but an algo error which triggered a flash crash
You might be wondering what a flash crash is; a flash crash is essentially where a market crashes due to the rapid execution of algo orders which all trigger one after another. Typically these crashes occur during hours of thin liquidity such as overnight trading where there are gaps in the order book, and the price jumps lower, chased by algo orders which push the market deeper and deeper.
Sterling Flash Crash
In October 2016 GBP suddenly collapsed 6% lower during overnight trading due to heavy algo selling during thin liquidity. Flash crashes have become an increasingly common occurrence as algorithmic trading continues to gain market share and the risks of automatic execution programmes are a strongly debated area. Algorithmic programmes have the ability to act and react far quicker than human traders and periods of sharp price movement are accelerated due to this.
Summer Wipeout
The Sterling flash-crash echoed the events of August 24th, 2015 when the Dow Jones Index dropped a massive 1,100 points during just five minutes of trading, sending heavy ripples across global markets. Indeed, high beta currency pairs saw significant declines in response as automatic sell programs triggered massive collapses across risk-correlated pairs. However, automatic programs are not solely to blame, and one of the elements that has been named as exacerbating these episodes is that of dealers selling to hedge their options exposure.
How Options Hedging Affects Markets
During times of market panic, many traders buy put options which means that they make money if the market goes down. Consequently, the dealer loses money as the market sell off and so to try and mitigate their losses, they sell the underlying market. During period of mass panic where large amounts of put options are purchased, dealers need to sell equally large quantities of the underlying market to mitigate their losses
So there you go; the next time you see the market crash seemingly out of nowhere you can assume that either someone has accidentally added a few extra zeros to their order or the algos have gone wild!
