November 1


High Frequency Trading in The Foreign Exchange (FX) Markets

High Frequency Trading (HFT) consists of the predictive buying and selling of contracts using algorithmic trading software and ultra low latency trading infrastructure where fractional increments of money can be earned in sometimes microseconds( millionth of a second).  The trading technique as such as been used in various forms as markets evolved and equity trading matured.

With the ascendency of new algorithmic trading firms with their cutting-edge, technology-driven trading strategies with the goal of earning profits in billions of dollars, HFT has become the wonder-strategy for low-investment, high-profit trading opportunities.  Today, nearly seventy-three percent of US equity markets> transactions run on HFT ensuring high-liquidity and price-visibility.

HFT and newer opportunities for High Frequency Trading in the Forex market

In fact, it has been quite a mixed bag for HFT in the U.S. Non-technology traders are disconcerted with unfair advantage gained by new-age-automated trading firms. Besides, they are also affected by the drastic fall in profit earning due to the thin spread of revenues HFT generates.

First a look at High Frequency Trading

High Frequency Trading, is a typical trading strategy, where sophisticated algorithms running on advanced servers identify trends in national and international market places, analyze them and place ‘flash orders’ all within one-millionth of a second. Though they trade only for a few seconds, high volumes are involved. Market places rebate such deals and help these firms make their fraction-of a penny profit. Again, firms now have access to high volumes, priority information much before off-line or slow-traders, and make a cool profit by reselling.

High Frequency Trading   in FX

Before 1990s, FX market too, operated on broker-dealer market and involved placing orders over telephone. However, with electronic trading, FX markets too can handle high volume trade.

The Forex market’s intrinsic characteristic of high liquidity and low volatility provide the right ecosystem for deploying the HFT strategies. These are ideas adapted from the equity markets and time-tested: market-capture, predictive and arbitrage.

Typically, a high-frequency trading firm will run several trading strategies with very low-margins, on custom-built software through intermediaries. Each firm thrives on minimum-latency of ‘flash orders’ of the software to move in-and-out of markets.

In fact, in Melbourne, a large FX fund has been usingHigh Frequency Trading in FX, successfully for well over a decade.

Insight into High Frequency Trading in FX

A recent by BIS reflects the role of HFT in FX marketplaces.  The report says that, there is an increasing use of HFT in FX market in the past few years as there is greater infrastructure available for electronic trading.

It was found that, in the FX market, HFT was active in most liquid currency markets and prevalent among dominant currencies.

It relied on operating high volume but very small orders, maintained low-margins along with low latency. This meant that all orders were placed and withdrawn in a matter of a few milliseconds.  Specific ‘algorithms,’ which analyzed the market, were used to perform these strategies. Another noticeable trend was that most traders adopted short risk holding periods of less than five seconds for greater efficiency.

The report predicts that HFT will spread to currencies, which are traded in lesser volumes as well and will likely be used in currency markets of emerging economies.

HFT is found to have a profound impact in the FX market places where it has been deployed. HFT effectively increases and distributes liquidity amongst all market segments. Though it does bring in greater efficiency into the system, it also cuts down on the profit margins. The true understanding of HFT’s impact on the FX market ecosystem will require a longer period.

Agencies/Firms adopting high frequency trading in Fx

Currency derivatives are a very large market segment and high frequency trading is a lucrative strategy, most major players in FX are fast adopting.

One of the early adopters of automating their currency management is Credit Suisse Group AG, Royal Bank of Scotland Group PLC and some of the leading names in hedge funds.

Globally, HFT is responsible for thirty percent of the activity in foreign exchange markets  and are high performers in trading with euro and dollar currency pairs.

GoldmanSachs, Bank of America, and Merril Lynch are known adopters of HFT in equity market scope.

High frequency trading in fx in the US

Post May 2010 and the debacle of market debacle triggered by HFT, the SEC in the US will introduce stringent regulations to control its use in the securities industry. It is likely that there would be regulations introduced in the FX market too. An estimated guess, suggests that close to two-thirds of the volume trade in FX uses HFT.  Hence, transaction taxes, limiting the order time are possibly areas of regulation that could well be implemented.

 High frequency trading in fx is the ideal trading platform for all stakeholders as the automated process ensures minimal risks, low-margins but excellent turnover profits.


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