Following the sterling flash crash last year, there has been much industry debate about what the increasing regularity and severity of these events means for FX market participants and whether anything can be done to prevent or mitigate their impact in the future.
According to Neil Crammond, risk manager for FX at Avem Capital, part of the reason why these flash events are occurring is simply that markets aren’t used to the levels of volatility that used to exist prior to the financial crisis and the implementation of quantitative easing by a number of central banks.
“I think that the problem with the modern FX market is that pre-2008, if you came in every day and someone said to you that ‘we’re going to have a 300 tick move in the cable every day’, you’d trade according to that,” he says.
In contrast, he explains that volatility has become so contracted in the FX market in recent years that a movement of 100 ticks is considered a volatile market.
“If you go back to when central banks weren’t in control of the market every day, you had one, two or three per cent moves all the time, so a flash crash of five per cent wasn’t uncommon,” says Crammond.
Although volatility is an important part of FX markets, he makes the case that there are steps that can be taken to help ensure that markets remain orderly, even in stressed conditions. One suggestion he puts forward is to introduce limits on how far the market can move within a specific time frame.
“Why do we trade markets? We trade markets for volatility, don’t take it away. But then again, a five or ten per cent move in 10 seconds, is that fair, is it orderly, do you have limit up or limit down?” he questions.
Crammond makes the case that having these limits, whereby if a market suddenly moves two or three per cent it briefly suspends trading, could enable markets to remain orderly while also allowing for volatility.
“What happened in the Asian market was that it was a 10 minute nightmare, and in theory you could have stopped that,” he says, later adding “There were [limits] brought in 40, 50, 60 years ago exactly to stop what happened on that sterling flash crash.”
You can watch the full interview here: