What Brexit Showed us About People’s Understanding of Markets

Thomas Walker July 19, 2016 0
What Brexit Showed us About People’s Understanding of Markets

In the aftermath of the Brexit vote, a lot of remain supporters were very quick to point to the markets for evidence of what a calamity the outcome was going to be.

Surely enough, stories aplenty emerged from the mainstream media with such headlines as “FTSE 100 and Sterling Plummet“, “Sterling Falls and Bank, Airline and Property Shares Tumble” and, perhaps best of all, “More Than £50 Billion Wiped off FTSE 100“.

The charts presented in the BBC article show massive moves with values plummeting as Brexit shocks the economy. But anyone who’s taken aback by these images is clearly unfamiliar with how markets operate.

bbFirstly, these are hourly charts, showing the price action over the course of one week. Conversely, to the right is a weekly chart for the FTSE 100. Brexit is represented by the fifth candle from the right, the red one with large wicks on top and bottom. The relatively small red area indicates the total drop from the start of the week to the end, while the wicks represent the total price movement during the week.

Suddenly, the move doesn’t seem all that significant. The thing is, as many central bank interest rate announcements will show, markets react violently to news all the time. A chart with a sudden drop will be a common sight to any trader. Certainly, the post-Brexit one was particularly large, but that was to be expected. As the chart to the right shows, the FTSE quickly recovered.

This is how markets behave. When major news happens, traders react quickly, either to profit from the move or shield themselves from losses. Price will drive down, or up, and then retrace back somewhat. After a while it’ll carry on with its usual movements and the event will disappear into the background noise.

Furthermore, the idea that £50 billion was somehow ‘wiped off’ the FTSE 100 is even more problematic than this over-hyped reaction to a short-term move. A large amount of the force behind this move is intra-day traders moving their positions around to try and protect their profits and assets. Any investor who sold at the bottom of this move would have been mad. As soon as the main move had passed, bullish traders returned and money quickly began flowing back in. Again, this is just how markets work.

Unlike the FTSE, sterling hasn’t recovered its losses in quite the same way. However the drop in value of the pound is a two-edged sword, as it can drive up import prices and make holidays more expensive, but it also makes exporting more lucrative and offers an incentive for tourists to come to the UK.

The overall point here is that it’s very easy for the media to show people a dramatic graph and exclaim about how Brexit has ruined the economy. The fact that’s been so successful points to a serious lack of understanding about how markets operate.

Part of this is down to the lack of finance and economics in mainstream education, while part of it is also down to the way in which the media presents the information. Most people have next to no understanding of how the finance industry works, and telling them that the FTSE has ‘plummeted’ is as good as saying that the economy is completely wrecked, when in fact all it means is that traders did what they always do and traded a news event.

The longer term economic consequences of Brexit are another discussion, and the markets will react to whatever developments transpire over the coming months and years. The real take-away from this is that market moves need to be seen in a longer-term context. They should be taken simply as traders reacting to news, not news in their own right, and certainly not a sign of major economic calamity.

It would be a much better world if schools taught economics and finance the way they teach citizenship. Perhaps then people would understand markets and their movements, and maybe even get involved, instead of perceiving the industry as an impenetrable world reserved for a privileged few.

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