There is little doubt amongst foreign exchange markets professionals and traders alike that after Black Thursday of January 2015, the foreign exchange industry will never be the same. While the implications of the events that happened on that day will stay with us for quite a while, we will delve deeper into the experiences of traders and brokers alike in a brief chronicle of the EUR/CHF turmoil.
Our reporters have contacted a number of brokers to ascertain what caused the great differences between their performance for their clients and for themselves during the Swiss black swan. The first in a series of articles is about OANDA.
Traders who used stop loss orders at OANDA were among those least affected amongst their counterparts across the wide spectrum of the foreign exchange market. We have heard about some stop loss orders executed in the high 1.19s on the EUR/CHF, while a number of traders managed to exit and some even shorted the market in the 1.17s area.
A number of stops got triggered just below 1.20, and for a period of time the price quotes on the CHF crosses froze across trading screens worldwide.
The big difference at OANDA was that during this freeze, after the initial turmoil some clients managed to execute sell orders above 1.1700 at market prices quoted by OANDA’s system. There was about an hour and twenty minutes when no trades were possible, because of the lack of pricing from major liquidity providers.
Those trades could be seen being accumulated, essentially creating a free arbitrage opportunity for a number of its clients. However, in the aftermath of the announcement OANDA chose not to break and re-quote trades.
We have asked company representatives about the implications of the event on the company’s business, and got some insights as to what exactly transpired behind the scenes. How did the firm manage the exchange rates in the aftermath of the announcement and why did it take the decisions it did in the aftermath of the black swan which hit us last week?
Speaking to Forex Magnates, the company’s CEO Ed Eger stated, “We have always ran our business on a clients first basis, looking for our customers’ best interests. We never re-quote and always execute the trades we say we will execute.”
How Did OANDA’s Systems React to the Black Swan
On the technical side of the matter, OANDA’s Vice President of Trading, Courtney Gibson, shared with Forex Magnates’ reporters some interesting insights.
Elaborating on how the broker’s system performed last Thursday, Mr. Gibson said, “The ability of a broker to respond to market conditions which we saw last Thursday really hinges on the quality of their technology. In normal market conditions we look at things like leverage and the investor’s responsibility to manage risk, however last Thursday we have seen a different scenario as extreme volatility has hit the markets.”
“The main responsibility of a broker in such abnormal market conditions is appropriate order execution, margin calls and margin closeouts which happen. The speed with which a system can recognize that and can fill those trades without getting bottlenecked and its ability to react to that change in a timely manner and to process the flood of transactions is key,” Mr. Gibson explained.
During the time when the markets were falling, there was a lot of confusion amongst liquidity providers (LPs) about where the market was and what a fair price was. Mr. Gibson said, “OANDA’s market-making system goes out and averages the quotes from the LPs, finding a consensus view of the market price.”
“Its ability to find the price at that point in time was crucial to preventing disastrous fills for most of our customers. If your model is to take a trade from customer A and match it with a liquidity provider B, some clients can get very good prices, while others can get really bad awful prices. In essence its going to be down to whom you were able to connect your clients to,” he elaborated.
OANDA’s Vice President of Trading further elaborated, “The way that we run our system is to create that consensus price view where we price our customers and then we take care of the smart order routing problem about how we split up the trades, who do we send them to, can we do some netting internally, etc.”
Commenting on the internalization of order flow, Mr. Gibson said, “OANDA does not internalize a tremendous amount of risk so we were certainly dealing with partners while the events were unfolding.”
“We ourselves certainly did some dealing at prices below what we quoted our customers and there was an economic impact, but we made the decision not to break trades and not to re-quote our customers. Similarly we credited our clients’ negative balances,” he concluded.
Potential Regulatory Challenges – Good Times for M&A
Forex Magnates asked OANDA’s CEO Ed Eger about what the potential implications for the industry going forward are and he said, “Though the events on Thursday were absolutely an anomaly, falling out of that, regulators may consider the absolute segregation of client funds, as well as stress tests to ensure all brokers can better manage risk in an event like this.”
“For example, in the case of capital requirements, we are over capitalized at OANDA and it helped us. It means that our business is able to keep running at full tilt, we can look at M&A opportunities given forthcoming market consolidation,” he elaborated.
Regulators may also make open positions reporting mandatory. In the spirit of our transparency, we already do this today (OANDA Forex Order Book).
“Most Experienced & Successful Traders Use Low Leverage”
It is no secret that high leverage ratios have been at the core of the problems which the FX industry has been facing in recent years. The Swiss black swan has demonstrated that as surprising it may seem for many brokers, higher leverage can turn from a cash-cow into a fatal disaster.
Elaborating on leverage ratios, OANDA’s Mr. Eger explained, “With regards to leverage specifically, OANDA has always maintained a conservative leverage policy – in some cases, offering lower leverage than required by regulation – and through our client education, we stress that clients need to consider a low-to-moderate use of leverage.”
The interview with Mr Eger ended on a useful note to traders and brokers alike – leverage is a double-edged sword.
Mr. Eger said, “From looking at trading behavior, we know that the most experienced and successful traders use low leverage for reasons like what happened on January 15. Leverage is a double-edged sword. Hence the regulations that exist to help protect customers. All brokers need to play a part in that.”