In the 1910s, US sportswriter Hugh Keough coined the phrase “The race is not always to the swift, nor the battle to the strong, but that’s the way to bet”. Fast forward 100 years and with so many price discrepancies between currencies across all parts of the world, whoever has the fastest access to quotes will always be well placed. The trouble is that the fragmented nature of the FX market means speed alone is not enough.
Accurate communication among increasingly disparate trading venues is one of the biggest hurdles traders need to overcome — particularly those harbouring hopes of grabbing limited liquidity observes Fraser Bell, chief revenue officer at BSO.
“Emerging markets are seeing a boom in OTC FX derivatives as traders hunt for liquidity, so speedy access to quotes in places like Mumbai or Dubai means new profit opportunities,” he says.
Fraser Bell, BSO
Another challenge is the rising cost of maintaining a speed-related edge, which inevitably erodes profits over time. This has prompted several high frequency traders to change tack over the last 12 months or so, with Virtu Financial acquiring KCG and Teza Technologies quitting its proprietary trading business.
Taking market structure and market impact into account has become even more important and that is unlikely to change in the future as the FX market continues to attract participants from other asset classes.
“There has certainly been a reduction in the number of individuals employing latency related strategies and others have decreased their reliance on such strategies,” notes FXSpotStream CEO, Alan Schwarz. “That is not to say that there are no latency trading strategies being deployed in the market. However, the number has fallen and low latency is increasingly being used in combination with other trading methodologies.”
Roger Rutherford, chief operating officer at ParFX, suggests that diminishing marginal returns and exponential cost increases have forced high frequency traders to accept that speed is no longer enough to stay ahead of the game. As a result, there has been a distinct shift towards strategy and analytics in order to make smarter trading decisions and gain a competitive edge.
He acknowledges that low latency trading by non-bank institutions provides significant benefits to the market and plays an important role in creating liquidity, reducing spreads and lowering the cost of trading. However, he says it has also led to a rise in disruptive trading behaviour.
“Merger and acquisition activity among non-bank electronic trading firms highlights how these once nimble institutions are now taking steps to adjust their operating models to manage costs, introduce new products and trading services, or simply increase in scale and size across new asset classes,” adds Rutherford.
According to Alexander Ridgers, head of analytics at MahiFX, low latency trading strategies need to have an extra edge to be profitable, which comes in a number of differing forms of market observation.
The market is continuing to change, which makes other factors – such as transparency, liquidity and quality of execution pricing — more important to the trading policy and strategy adds Henry Wilkes, founder of Institutional FX Advisory Partners.
Roger Rutherford, ParFX
“There needs to be a greater emphasis on the efficiency of the whole trading process rather than just the speed to market, which will involve a complete health check audit of trading policy, strategy and process including market, operational and compliance risk,” he says.
Certainty of execution may be more critical over the long run. For those participants whose position holding times is measured in seconds or milliseconds, speed can be life or death, but for many market participants there may not be a profit or loss component that drives the execution per se.
To those for whom FX trades are functions of securities funding, corporate activity or other non-profit-seeking financial transactions, full execution with minimal information leakage is more important observes David Ullrich, senior vice president execution strategies at Flextrade.
“Among high frequency traders, microsecond momentum factors dominate trading styles and this agreement in price makes liquidity more fragmented for this subset of FX players,” he concludes.
“Furthermore, the actual liquidity underpinning the current market place is aggregated and redistributed across a multitude of networks, creating a liquidity mirage as opposed to actual tradable amounts. Perhaps the best outcome would be the creation of a playing field where relative latency is equivalent across all market participants.”