In this part of my series on algorithmic trading, I’ll be zooming in on the recent developments of this strategy in the forex arena. Before you read on though, make sure you’ve seen the first and second part of this article series!
As you’ve probably guessed, algorithmic forex trading has been on the rise in the past few years, as the appeal of automated trade signals and quick execution with minimal human supervision boosted interest and demand for “black box” systems. According to the “FX Electronic Trading 2014 – Global Trends and Competitive Analysis” report from Greenwich Associates, the usage of algorithmic trading has grown from 7% of forex market participants in 2012 to 11% this year.
In addition, Greenwich Associates predicts that the market share of algorithmic trading will reach 18% of forex traders by the end of 2014. And that’s just on the retail level!
The adoption of algo FX trading systems among hedge funds and institutional trading firms is projected to be significantly higher, as these market participants enjoy larger capital and can be able to make the most out of higher trading volumes. “Hedge funds using algos execute even more volume through them, over 50%, and we expect that to only increase,” said Greenwich Associates Market Structure & Technology head Kevin McPartland. Other studies indicated that high-frequency trading systems account for roughly 75% of volume among larger funds.
Of course the development of algo systems throughout the years and across various financial markets has been riddled with a few problems here and there. A couple of years back, the opening of the BATS (Better Alternative Trading System) Global Markets exchange – an ECN stock exchange with trading systems based on trade bot, a computer program performing algorithmic trading – set off a market glitch among several equities.
“Black box” systems have also been blamed for a flash crash that occurred in May 2010 when Waddell & Reed Financial, Inc. implemented an algorithm that triggered a feedback loop among its high-frequency trades. No need to go into the nitty-gritty of this blunder, but you should know that it sparked the largest intraday dip in the Dow to the tune of 998.50 points!
Back in 1998, a highly-leveraged quant hedge fund trading in the fixed-income market got instantly blown out when Russia announced a default on its bonds. The government had to scramble for a bailout plan for this firm in order to prevent contagion and a full-scale debt crisis from happening.
In the forex market, several firms have already been placed under scrutiny for being suspected of using algorithmic systems that are designed to manipulate WM/Reuters exchange rates. Industry watchdogs are also looking into the possibility that traders may have colluded with dealers in order to push forex rates in their favor during the 60-second windows before the benchmark rate are set.
Suffice to say, this part of the financial industry could be in for even more promising developments in the coming years but this merits closer regulation as well. I’ll be sure to share any updates with y’all so stay tuned!