Over the years, global forex markets have experienced several flash crashes. However, these crashes have become more frequent over the last few years, with at least three experienced since 2015. The most notable ones came following major events for the respective countries.

The EUR/CHF was the first major flash crash over the last two years. This came following the decision by the SNB (Swiss National Bank) to unpeg the Swiss Franc’s 1.2000 exchange rate limit against the Euro.

In January, last year, the Russian Rubble plunged to new multi-year lows against its forex counterparts prompting the Russian government to undertake measures to stabilize the currency while in June, the British Pound fell to the lowest level since 1985 following the Brexit vote.

In each of these occasions, several traders and brokers were caught unaware thereby losing millions worth of risk capital. Therefore, traders are now becoming more cautious in selecting their preferred brokers.

Some brokers have taken various measures to protect themselves and their clients against the effects of a potential forex flash crash, but others are still toying with the situation. One of the ways of identifying a broker that has taken the necessary measures is by checking whether the broker has an A-Book model, which allows them to transfer clients’ orders to the interbank market. This protects the broker against sharp volatility spikes, which reduces the chances of bankruptcy or insolvency. More information on factors to consider when choosing your broker can be found here.

Systemic events, market volatility, and slippage

Systemic risk in the forex market is on the rise as geopolitical and fiscal policies continue to dictate the direction of exchange rates. There are those who believe that fundamentals are having a lesser role to play in the volatility of the foreign exchange markets. This is one of the reasons why many brokers are being caught off-guard by slippage triggered by systemic events.

The EUR/CHF flash crash led to the bankruptcy of various brokers in the forex trading market. Some of them were notable brands while other big players lost hundreds of millions. Now, in the event of a flash crash that leads to bankruptcy, a broker that does not transfer client’s orders to the interbank market is unlikely to reimburse all clients their funds because the losses incurred due to volatility slippage could lead to negative balances. Therefore, the risks associated with volatility slippage are not only lethal to the broker, but also to its clients.

While large brokers like FXCM (NYSE: FXCM), Alpari UK and IG Capital Markets suffered tremendous losses, while others claim to have managed to “dodge the bullet” and protected traders through their risk management systems against negative balances.

Fixed spreads prevent traders from sharp spikes in volatility while variable spreads can lead to massive losses. And while some traders tend to prefer variable spreads because of the potential gains associated with a spike that favors their trades, in most cases these gains are never realized.

This is because most brokers offering favorable spreads readjust their spreads to match any unforeseen volatility in the market.

Time to watch out for more flash crashes?

Markets will always be volatile, but the level of volatility can vary from one period to another. The year 2016 was characterized by a number of systemic events that led to the collapse of various currencies. In 2017, we could easily witness a couple more crashes should some of the expected events come to pass. One of the few that look set for a dive is the AUD/USD.

The Australian Dollar could be on the ropes towards the end of the year should the US Federal Reserve rate surpass the Reserve Bank of Australia’s cash rate. Currently, the RBA cash rate stands at 1.5% while the US base interest rate is pegged at 1.00%. In addition to this, investors highly expect at least two more US rate hikes before the end of the year. These could level the US interest rate with the RBA cash rate at 1.5% (assuming the 0.25 points periodic hike is maintained) while a fourth rate hike in 2017 would send it to 1.75%.

Based on current economic and interest rate hike projections, analysts predict that the Australian cash rate is unlikely to go up this year, with a downward cut a more likely option. The last time the US interest rate was above Australia’s cash rate was 15 years ago, during which the AUD/USD exchange rate plunged to about 0.48.

Conclusion

In the event the US interest rate exceeds the Australian cash rate, there is a likelihood that the Aussie could go crashing against the USD thereby making it the flash crash of 2017 in the currency markets. So, is your broker ready for this potential crash?