Technology Allows Investors to Build ‘Fortress’ Around FX Activities09.02.2015
By Michael DuCharme, head of currency strategy at Russell Investments
Long ago people built villages surrounded by thick walls for safety, and guards only opened the gates to admit those who posed no threat to the inhabitants. Now, technology gives the investment community the opportunity to build an impregnable fortress around their foreign exchange (FX) trading activities, allowing them to transact with one another in a safe environment. And when it’s time to go to market, investors are equipped to recognize the possible dangers and venture out well protected with information.
While currency investors today don’t fear for their physical safety, the need for protection is no less real. Investors have borne high FX-related costs from relentless sacking by those armed with better information and technology. The scale of those costs is reflected in staggering penalties and settlements levied against some of the worlds’ largest currency trading institutions. U.S. and UK regulators have fined these firms substantially for colluding and manipulating a key foreign exchange benchmark rate. That’s on top of the hundreds of million –or even billions–in damages some institutions have paid because their customers claim they were overcharged for foreign exchange transactions.
Common to both circumstances is the principal model of trading in which one party to a transaction seeks to profit at the expense of the other. Fortunately, new trading applications allow investors to first trade with one another in a protected setting much like the walled community. Admittance to the community is exclusive: Only those investors who are trading foreign exchange to support another investment activity (such as converting foreign dividends) are invited to trade. This exclusiveness provides investors with a safe forum so they don’t need to worry so much about profit hungry traders. If more trading is needed after this community session to complete an order, the investor can turn to the principal market with technology that empowers the investor with real-time information in a highly competitive environment.
Community trading offers other attractive benefits besides protection. First, trades are matched at a mid-point price, meaning each party to the deal saves equally on the typical costs to trade. If more trading is needed after matching, the investor can trade in the market with a view into real-time exchange rates. That information helps the investor decide how much can be traded and at what price, giving the investor more of the necessary information to manage costs. Sophisticated non-bank algorithms are available (and non-bank is important because precious investment information represented by the trades won’t be mishandled). And if best execution means turning to another trading venue, then that’s easy to do too.
Technology—in the form of cannons and other weapons—evolved to breach physical barriers. Investors need to be ever vigilant and willing to take necessary steps to avoid the fate of walled communities. But the strategies of trading with trusted parties and being armed with information give one a fighting chance to survive.
Mr. DuCharme is a registered representative with Russell Implementation Services Inc., a FINRA member firm.