All the Theories Behind the Pound’s Recent Plunge

sterling fall All the Theories Behind the Pound’s Recent PlungeOn Friday 7th October the British pound sterling suffered its largest drop since June 24th 2016 when the UK voted to leave the EU, as it fell by 6% in just two minutes. At one point it hit its lowest level since 1985 when the mining strike was going on and the pound was valued at $1.0520, though this time its trading price of $1.1819 was a little higher.

It recovered to $1.24 after that dramatic drop, but the damage was already done due to a big selloff of the currency. Straightaway experts and investors were trying to track down what led to the surprising plunge, with a number of interesting theories cropping up.

Fat Finger Error

One of the most popular theories behind the crash was that it was simply a fat finger error. This is when a keyboard input mistake happens in the financial markets, usually to buy or sell a lot more of a particular commodity or currency than was intended.

In this case, it is believed that a fat finger error meant that large amounts of the pound were sold off in one go by accident. A huge wave of stop-loss orders were then triggered, as the pound fell below a specific value which meant many other traders’ investments in the pound were automatically sold to avoid them making a loss.

Robot Traders

When in doubt, blame robots! Well, that seems to be the attitude of some investors and financial experts, as the pound’s crash occurred around midnight UK time during a period when few traders will be active. They believe this points the finger to a computerised problem from a robot trader and not human fault.

Whether it was human or robot, the computerised systems involved in trading these days reacted to the drop and exacerbated the effects. A human trader would have been more likely to spot the strange pattern and not overreact.

Brexit

It was the Brexit announcement that caused the initial drop in the pound’s value back in June, and the ongoing uncertainty has meant it is yet to fully recover to pre-Brexit levels. However, in the recent negotiations there were comments from EU leaders such as Francois Hollande and a Financial Times article released which all mentioned fears of a hard Brexit policy.

Once again this will have undoubtedly thrown up a lot of uncertainty about the pound and fx markets, leading many traders to sell the currency off. It could simply be that a lot of traders took note of this news and decided to do so in a similar time period, though within the space of just two minutes seems far too coincidental.

Low Liquidity Selloff

Another theory is that it was simply a large barrier option that traded and cause the selloff in light liquidity. Usually when this occurs there is a subsequent reversal, which has happened with the pound discovering a new rate at 1.24 per US dollar. However, because other currencies did not experience similar moves, there are some doubters as to whether it was a liquidity issue.

Faulty Algorithms

In a similar way to many people thinking the drop was down to robot traders causing errors, others suspect that it was faulty algorithms that caused it. This is not a human error directly, and because it was only the pound affected there remains a little doubt. Yet the fact it happened overnight signals that there was an electronic element gone wrong at play.

Whether the cause of the pound’s plunge is ever discovered or not, plenty of uncertainty looks set to remain with the pound, so traders should be wary in the near and distant future.      

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