TOKYO -- The Japanese yen briefly hit a nine-month high against the U.S. dollar on Jan. 3, soaring as much as 4 yen, or 3.9%, in just one minute as hedge funds and other overseas investors took advantage of thin liquidity during the New Year's holiday here.
The yen's sharp rally, or a "flash crash" in the dollar and other currencies, was driven by massive buying of the yen as a sharp rise in the Japanese currency triggered stop-loss orders from retail investors in Japan and then artificial intelligence-based trading systems worldwide.
"Speculative buying by overseas investors appears to have started it all," said Yoshifumi Takechi, chief analyst at foreign exchange broker Money Partners.
A little after 7:35 a.m. on the day with the Tokyo market closed, the yen jumped to 104.10 against the dollar from the low 108-yen level. Less than an hour later, it plunged to 107.90 yen.
"I've lost 24.5 million yen ($226,000). Please share this information as a lesson to others," an investor tweeted. The tweet was shared by about 1,000 investors.
Early-year yen trades are extremely thin as Japanese traders are on holiday. Overseas investors took advantage of the break, catching Japanese investors napping.
Recently, many retail investors are leveraging the Bank of Japan's negative interest rates to use the yen as a cheap way to purchase higher-yielding currencies. And while many foreign exchange players trade daily, those trying to earn on interest rate differentials tend to hold currencies longer.
Many of those investors had set stop-losses to kick in at 108 yen. When the yen broke above 108 to the dollar on Jan. 3 due to overseas buying, stop-losses triggered more yen buying and the selling of foreign currencies.
"Targets [on Jan. 3] were possibly those holding foreign currencies to take future profits on interest rates," said Seiichi Tanaka of Mizuho Bank.
According to a market player, stop-loss orders by Japanese retail investors on Jan. 3 soared roughly 10 times from the previous day. Total market losses could approach the 3.3 billion yen mark incurred in 2015, when the Swiss franc soared due to the Swiss central bank halting currency market intervention, the player said.
AI algorithms fueled further buying after the rising yen also triggered their own stop-loss mechanisms. These programs -- used by many hedge funds such as commodity trading advisers, or CTAs -- are designed to generate profits based on breaking news and developments in the market, automatically placing sell or buy orders as needed.
Nomura Securities estimated that CTAs' break-even points for their short positions stood at about 112 yen to the dollar for the period from August 2018 to Jan. 3. They likely set their algorithms to close out when the yen appreciated above 108 to 109 yen.
According to Nomura's Masanari Takada, "CTAs' [stop-loss] algorithms were the main target of [speculators]." As a result, traders who bought at 108 yen and sold at 104 yen earned 4 yen per dollar in about a minute.
"Flash crashes" are increasing across the world. The British pound lost nearly 9% in tens of seconds in 2016 and the Turkish lira also tumbled last year. Both crashes occurred in low-liquidity markets early in the morning in Asia, hitting Japanese currency investors hard.
Market players are nervously poised for another "flash crash" during Japan's Golden Week holidays between late April and early May. "Investors need to put in more margin money than usual," said Yoshihiko Kobayashi of foreign exchange broker JFX.
Foreign exchange brokers issued the same warning at the end of last year, but neither investors nor AI algorithms heeded the advice and paid for it.