HFT and FX: A Volatile Mix

Terry Flanagan

The evolution of the FX market from a phone-based system to one that’s largely automated has brought benefits in the form of greater liquidity and lower transactions costs, but it has also raised the risk that some high-frequency trading strategies could be used to unfairly gain an advantage.

ParFX, a spot currency platform operated by interdealer broker Tradition, was founded on the premise that market participants should be able to trade without fear of being at a disadvantage technologically.

“ParFX is a matching environment for spot foreign exchange that is built on fairness and equality,” said ParFX chief operating officer Roger Rutherford. “By that, we mean that everyone interacts with the system in exactly the same fashion – there is no way for any participant to buy an advantage over the next person. We pioneered a unique matching mechanism that applies a meaningful randomized pause to each order submission, amendment and cancellation. This means that traders are unable to gain any advantage via speed, using ultra-low latency trading models, for example.”

ParFX has devised a matching methodology intended to take the advantage away from ultra-low latency sensitive models. “ParFX is absolutely not anti-HFT,” said Rutherford. “Open access is central to our ethos and we welcome participants from all sectors of the FX market. In fact, we have seen significant interest from HFT firms, most of which run a variety of different trading strategies – some of these are based primarily on latency, and some are based on relative value.”

The randomized pause on the platform is between 20-80 milliseconds. “It’s less than the blink of an eye for a human being, but in high frequency terms, it completely nullifies certain disruptive trading behavior,” Rutherford said. “If you are coming to the market to exchange risk with good intentions, then 20-80 milliseconds has absolutely no impact on your business.”

A 2013 report by the Bank for International Settlements noted that algorithmic trading has become pervasive among dealers and end users alike.

“A lot of growth in spot FX has been underpinned by the electronic evolution of foreign exchange, and hence we’re at $5.3 trillion a day,” said Rutherford. “It’s a significant asset class. Algorithmic trading strategies are everywhere.”

It’s important to distinguish algorithmic from high-frequency trading, a subset characterized by extremely short holding periods at the millisecond level and a vast amount of trades often cancelled shortly after submission, the BIS report said.

ParFX was born from the FX Pure initiative, which involved a group of the world’s leading FX trading banks coming together to respond to industry frustration at the increasing usage of disruptive trading strategies in FX markets and a technological arms race that placed an unhealthy emphasis on speed rather than strategy.

The platform now counts 14 banks among its founding members, the latest being Citi and J.P. Morgan, which further expands ParFX’s global distribution network as the platform is opened to the wider FX trading community.

In the coming months, ParFX will open up its system to the buy-side, allowing customers to trade through their prime broker alongside the banks on a post-trade disclosed basis.

“ParFX is the first platform to introduce a transparent prime brokerage model, enabling buy-side participants to trade at better prices with a wider community,” said Rutherford. “This addresses the growing concern that the lack of transparency in the traditional prime brokerage model encouraged disruptive trading behavior as buy-side participants were able to hide behind the mask of anonymity. This is nullified on ParFX, as all counterparties – executing broker, prime bank and prime client – are identified post-trade.”

Featured image via gitanna/Dollar Photo Club

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