E-FX Trading Sees Plateau
So, what is the best way to trade the foreign exchange markets?
In a market that trades 24/6/365, electronic trading makes the most sense. And according to market consultancy Greenwich Consultancy, the forex markets remain the most electronically traded market in the world. Of the total notional volume traded by institutional investors globally, 75% is now traded on the screen, up from just over 43% before the credit crisis. Seventy-two percent of investors trade at least some of their volume electronically.
The impressive adoption of e-trading in FX over the past decade stands out not only versus other asset classes, but also because it has developed via natural market demand and not regulatory mandate.
Greenwich analyst and report author Kevin McPartland noted that in the past five years, electronic trading in interest-rate swaps and credit-default swaps has grown rapidly to roughly two-thirds and 90%, respectively. But that growth was almost completely due to regulatory requirements mandating, in effect, “Trade electronically, or else.”
But is the there room for more growth?
Despite the FX market’s steady embrace of electronic trading, Greenwich said it might have hit a plateau. E-trading levels have remained roughly flat since 2013, signaling the market has hit the upper limits of on-screen trading and the next stage in its evolution.
But there is one FX trading area that can see growth – the retail trading space.
While FX trading has traditionally been was dominated by a handful of banks and custodians who traded on behalf of institutional investors, Vatsa Narasimha, Chief Executive Officer of OANDA, the online multi-asset trading services and foreign exchange solutions for individuals and businesses, thins otherwise. In a recent conversation with Traders Magazine, Narasimha spoke about the growth of the retail trading sector and the changing face of the industry.
“The retail trading industry as we know it today emerged as a result of developments in technology,” explains Narasimha. “On the institutional side, technology moved trading from the floor of the exchange to the computer screen, and over the last 15 years or so we’ve seen the same thing happen in the retail trading industry. Increasingly we’re seeing the use of technology to break down the information arbitrage that used to exist between institutional and retail traders. We continue to arm our clients with order book indicators and sentiment analysis, which provide retail clients with the same comprehensive view of client orders and positions that have long been the reserve of professional FX brokers.”
In 2001 the company launched a platform that helped pioneer the advent of Internet-based currency trading, introducing a host of first to market in the process, such as automated execution, instant settlement on trades, trades of any size between one and 10 million units, and interest calculated by the second.
However, while Narasimha stands proud of the accomplishments his firm have made in terms of democratizing the forex industry, he is quick to assert that there are significant risks associated with currency trading of which retail investors must be made aware. Leveraged trading does carry significant risk, due in large to the fact that rapid market shifts can result in losses that by far outweigh initial investments.
He also warned about the perils of leverage – in particular being over-levered when trading. He said that regulators all over the world have turned their attention towards reducing systematic risk caused by leverage in the retail trading industry in recent years. Japan and Korea have both already deleveraged products to protect investors from significant losses, and the UK’s Financial Conduct Authority (FCA) recommended traders with less than 12 months trading experience should be limited to 25:1 leverage, while experienced traders are can reach 50:1.
Narasimha adds, “We welcome this affirmative stance from the regulators, because we believe it’s important to create a fair and transparent arena in which retail clients can trade, safe in the knowledge that their best interests are being protected. This goes some way to explaining why we’ve always been conservative when it comes to margin requirements, often implementing leverage rates that fall short of market regulations to protect our clients. In the coming years, we will continue to support regulators all over the world in their quest to mitigate risk associated with currency trading.”
Algorithms have become more prevalent in the spot FX market.
Global Foreign Exchange Committee has made recommendations on Last Look.
There is a growing demand for transparency in FX trading by regulators.
CLS has also enhanced its existing suite of alternative FX data products.
FX Global Code sets out good practice for last look and provides illustrative examples.