Subject: Algorithmic trading:FX Market keeps machines in their place
From: "Michael Andrews" <[email-masked]>
To: "Hunter Biden" <[email-masked]>, "Devon Archer" <[email-masked]>, "Eric Schwerin" <[email-masked]>, "Curt Hastings" <[email-masked]>, "Neil Callahan" <[email-masked]>
Date: Tue, 28 Sep 2010 10:55:15 -0400

Algorithmic trading: Market keeps machines in their place
By Jeremy Grant
Published: September 27 2010 17:38 | Last updated: September 27 2010  
17:38
Ever since the “flash crash” of May 6 in the US, when the Dow Jones  
index plunged by an eye-watering 1,000 points in about 20 minutes, the  
machines that increasingly move markets have come under the spotlight.

Specifically, regulators question what role algorithmic trading had in  
exacerbating the huge price dislocations of that day, when the market  
also bounced back up not long after it had fallen.

Yet computer algorithms – or “algos” – are by no means used solely in  
equities markets. They are just as pervasive in options, futures and  
foreign exchange. In FX, about half of market activity is driven by  
some kind of algorithmic trading.

Specialist technology providers are scrambling to roll out the latest  
sophisticated systems designed to help FX traders use algos more  
efficiently.

In September StreamBase, a US-based company, teamed up with  
MarketFactory, a technology company providing algorithmic FX trading  
applications, to give hedge funds, banks and proprietary trading firms  
access to market data more easily.

Companies such as this know FX is growing faster than cash equities  
markets as a trading opportunity for algorithmically inclined traders.  
Indeed the Bank for International Settlements says the FX market grew  
by 20 per cent globally in the three years to April this year. Some  
exchanges that offer FX are doing even better: CME Group’s FX volumes  
grew 94 per cent in that period.

So could a “flash crash” happen in FX – and does the rapid growth of  
FX provide extra cause for concern?

Most industry experts start with the “never say never” caveat. But  
they all point out that the FX market structure has unique  
characteristics that mean it is less likely than some people fear.

One is that it is less fragmented across trading venues and pools of  
liquidity than equities markets.

In the US equities markets, one of the issues that regulators are  
focusing on is the fact that trading was spread across 14 exchanges,  
and the numerous different types of trading platform may have  
exacerbated price movements as traders switched back and forth from  
various venues trying to get out of their trades.

Dave Rutter, chief executive of Icap electronic broking, says: “In the  
equities markets there are thousand of securities that are traded  
thinly. If you take a look at our top [currency] pairs like the euro/ 
dollar or euro/yen, these are very deep liquidity pools with thousands  
of participants.”

He says algorithmic trading has been “an important part of our market  
for the last five years.

“We’ve seen that the algorithmic firms have added liquidity and added  
to the depth of the market.”

James Dalton, head of FX algorithms at Citi, says the FX market is  
nonetheless becoming more complex. There is no single source of real- 
time market data or volume “so you have to model it yourself”.

Moreover, algorithmic trading is a generic term that refers to  
electronic market-making (done by a handful of top-tier banks that  
dominate the business); “automatic technical trading” (often done by  
hedge funds); statistical arbitrage players such as high-frequency  
traders, who are simply, seeking to take advantage of speed; and the  
emergence of “execution algorithms” used by traders to get large  
volumes done but parcelled out into smaller trades.

Mr Dalton says “stat arb” players make money when markets are volatile  
but this can bring “a mix of benefits and dangers”, he says.

“That’s why more banks are starting to invest in building [execution  
systems] for their customers to use, so they can navigate those waters  
a little more effectively.”

However he also believes a “flash crash” in FX is unlikely.

“One that would bring the market to its knees? No,” he says. “The  
market’s just way too wired. A lot of the algo business doesn’t sit on  
particular position for very long.”

In the meantime, progress is being made in automating many mundane  
post-trade processes that are designed to give traders a better sense  
of who they are trading with, and the risks of default – known as  
“counterparty risk”.

Portware, an algorithmic trading technology company, said in May it  
had integrated one of its trading products with post-trade systems  
operated by Traiana, a company that specialises in middle- and back- 
office processing of over-the-counter derivatives.

This would allow Portware’s clients to “streamline post-trade  
processing and settlements with counterparties, resulting in lower  
operational risk and reduced trading costs”, the companies said.