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Risk Management

FX Algo Use Will Grow as Benefits Become Known

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February 15, 2018

Greenwich Associates says algo benefits will increase uptake of algo use for FX trades

econ and currency240In a world where the cost of FX trade execution continues to increase, corporate foreign currency traders are constantly on the lookout out for tools that provide more transparency and better performance. This is why more and more traders are turning to advanced execution methods like algorithms or algos.

“One of the key benefits of using an algo is the ability to clear risk at or inside the primary market spread, while minimizing market impact,” according to a new report by Greenwich Associates. “By using an algo of a leading FX dealer, a trader can ensure that they are able save on execution costs and also that their trades do not have a negative impact on the level of that currency pair post-trade.”

What are algos? They are a sole-source trade that executes over time, in small increments, in the bank’s name, using proprietary algorithms to mimic a style of trading. The customer – in this case a corporate – takes the risk and pays a fee vs. the bank taking the risk and charging a spread. By leveraging advanced trading techniques like algos, corporates can navigate the increasingly fragmented trading landscape that is evolving and optimize execution with access to providers’ proprietary algorithmic strategies that capture spread and minimize market impact. This is why algos will take on more important roles in the overall corporate risk-management setting.

But despite these benefits, the numbers are still small. According to Greenwich, about 10% of all dealer-to-client FX volume is executed through algos. But this number will grow and fast, the consulting firm says in its report, The Evolution of FX Algos: From Nice to Have to Need to Have.

“We anticipate that over the next few years, the market for FX algos will look more and more like equities,” Greenwich says, noting that more than half of all equity trade volume uses algos. “With the push from regulators, as well as best-execution committees and policies, traders are going to need to reduce costs while maintaining (or improving) the quality of the execution—two benefits that algo users realize.”

This view is backed up by numbers from independent electronic trading platform FXall, which alone has recorded a trading increase of 206% in average daily volume from 2014 to 2016. The company notes that this not only in the very-large trade space but also in the under-$20 million range. FXall users can choose from over 100 proprietary algorithms from 14 banks.

And traders that use algos have seen their trading costs decline. In the Greenwich survey, “nearly 60% of respondents note that they have materially reduced the overall cost of trading FX,” the firm says. “Additionally, over a quarter mentioned that using an algo means that their traders can spend more time on complex orders.”

One hurdle to using algos for many traders, Greenwich says, is the view that algos cannot be customized. “When traders who did not use algos were asked for the key factors holding them back, one of the top five reasons was feeling that they could not sufficiently customize the algo to meet their needs.” Greenwich says this can be overcome by having a “suite” of algos at the ready to “to meet various execution requirements.”

But even a suite can present a formidable decision tree. When Greenwich asked algo users on what algos to use for what trade, there was no hard and fast rule. Greenwich learned that “each trader has their own informal rules as to when using an algo makes sense, but none has a true formal process
mapped out. Until algos are more widely adopted—and there are more data points available—we expect this trend to continue.”

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