Positive Indicators & Market Volatility Accelerate Auto-Trading

Early trading data suggest institutional FX platforms have opened this year in better shape than they closed in 2022. Cboe’s institutional spot FX platform reported a 17% increase in total trading volume in January compared to the previous month, while Euronext’s trading volumes were up by 9.5% over the same period. It was a similar story at FXSpotStream and 360T where average daily volumes were up month-on-month by 5.2% and 13.9%, respectively.

While some of this increase can be attributed to lower trading activity in December as a consequence of the Christmas and new year holidays, it is also a reflection of positive indicators including more encouraging global economic data and continued market volatility on the back of interest rate policies.

A number of market participants agree that the most notable trend in the institutional FX trading space currently is the continued adoption of algorithmic trading.

“Over the past couple of years – and largely as a result of the coronavirus pandemic – uptake of FX algos has increased dramatically with clients and dealers looking to offset risk, access fragmented liquidity , and improve operational risk when working from home,” explained John McGrath, the Chief Revenue Officer at BidFX.

This growth has been further accelerated by the commoditised nature of FX trading, which lends itself particularly well to the rapid and widespread adoption of algos.

McGrath estimated that FX algo trading now represents as much as 20% of daily spot volume and said that this number is only going to increase as buy-side firms become more comfortable and reap the benefits of using the technology.

“Another notable trend is volatility, which goes hand in hand with the growing trend toward algos,” he added. “The return of volatility in the FX markets last year – driven by factors such as unpredictable fiscal policy from the UK government – has meant that algos will evolve yet again to become even more sophisticated.”

The impact of volatility is reflected across an institutional client base that in 2022 was preoccupied with regulatory changes and workflow efficiencies but is now more interested in liquidity availability and data management.

According to McGrath, while the impact of the pandemic continues to wane, the inflation hangover continues to affect institutional FX trades.

“Central banks began raising interest rates in 2022 to ease inflationary pressures, and it is likely that this will continue as many are expected to raise interest rates to their highest level in 15 years,” he said. “FX traders will be forced to adjust their strategy this year as risk factors that haven’t been relevant for a number of years come to the fore once again.”

The low-interest rate environment over the past decade has limited the scope for big carry trades based on interest rates or growth differentials. In this context, volatility presents opportunities and has provided a much-needed lifeline for institutional FX traders.

McGrath noted that interest in the bilateral clearing of non-deliverable forwards (NDFs) has been on the rise as institutional asset managers look to reduce the amount of margin they need to post under uncleared margin rules.

“FX is, after all, a by-product for the real money asset management community,” he said. “As opposed to trading currency markets for alpha, the vast majority of money managers are looking to manage risk around their currency exposures.”

An LMAX Group spokesperson suggested growing use of algorithmic trading has been fuelled by the increasing adoption of artificial intelligence and machine learning. She also suggested that cryptocurrencies have benefitted from positive risk sentiment in traditional markets in the early weeks of 2023, producing an uptick in volumes as more institutions see that asset class as a natural extension to FX trading.

This is reflected in LMAX Group trading data, which indicates that daily trading volumes picked up sharply in the second week of January following a relatively quiet period from the middle of November.

Jamie Trickett, the Global Head of GlobalLink’s FX trading platform product reckoned traditional voice relationships will remain important despite the growth of data-driven technology solutions used to create automated trading models and observes that institutional FX trading desks are evolving to become a hybrid of skillsets.

“Traders are constantly looking for enhancements in the speed and efficiency of executing trades as well as better and quicker access to liquidity, and, as a result, we are seeing increasing demand for our automated and algo trading solutions,” she said.

Institutions are investing heavily in technology to improve their trading process and data analysis. There is also a drive from the buy-side to streamline how their systems are communicating with one another as market developments force heads of desks to look at how they are managing staff and systems to ensure they are fit for the purpose and efficient across all asset classes.

“Smart trading solutions with an advanced level of interoperability will help improve efficiency and simplify FX trading workflows,” said Trickett. “Data offering independent and unbiased views is critical for institutions to enhance their ability to make more informed trading decisions.”

While increased electronic trading expands the amount of data available to clients, they still face the challenge of turning that large amount of data into actionable metrics to improve their trading outcomes. This had led to increased demand for real-time pre- and post-trade analytics to help traders achieve greater transparency in their FX trading and achieve best execution.

Trickett referred to a shift towards NDFs as well as options swaps from institutional FX traders as well as increased interest in algo trading and electronic trading. “We have seen an increase in automated trading volumes of 40% year-on-year,” she concluded.