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Demystifying Algorithmic Trading in the Forex World

This is the first article in a series sponsored by Thomson Reuters

Traders Magazine Online News, April 18, 2018

John D'Antona Jr.

Is the time ripe now for using algorithms to trade foreign exchange?

After decades of being used to trade equities and equity derivatives, and as institutional money managers move away from equities and into new asset classes such as forex, can algorithmic trading strategies be incorporated? Equity algorithms have had tremendous lead time to be built, adjusted and implemented in trading. Not to mention that equity algorithms have evolved from the simplest volume-based to the most complex that adjust themselves when seeking liquidity.

But there is a world of difference between the equity markets and the foreign exchange markets. In stocks, there are myriad public and private trading venues from which to use algorithms – upwards of 40 while the forex market is traded by or on a handful of bank trading desks - also known also known as a principal bank trading market or spot forward market. Also, the equity markets remain distinctly geographic with predetermined opening and closing times – Monday through Friday, for example. The $5.3 trillion forex market is open to trade 24 hours a day, 6 days a week all year long.    

So, can algorithms be successfully created and used in this highly liquid yet unrestricted market that is almost always open for business?

Neill Penney, Thomson Reuters

Neill Penney, head of Thomson Reuters FX Trading Business and Co-Head of Trading said yes, in a conversation with Traders Magazine. He said that algo use is growing in his asset class and that includes the use of trade-cost analysis (TCA) to find ways to improve algo and trader performance.

“Algo use is growing and TCA plays a significant part in an algorithmic trading strategy,” began Penney. “The people who are looking at algos and using them are our more sophisticated customers.”

So, why use an algo?

First, Penney said, was to reduce risk - signaling risk – as he termed it. This risk is dispersed over time by the algorithm doing what it is designed to do - parse down or slice up a larger parent order into smaller child orders. This not only reduces the spread a trader pays but also helps transfer risk.

Secondly, using an algo when trading forex it helps boost transparency in the market – which many agree is quite opaque. Again, in a bank principal-based trading market this is extremely important.

“The breaking down of large trades on primary market and getting smaller executions done gives people the proper ability to show multiple trade prints, and from public markets, and that is very valuable,” Penney said.

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