FX Market Turns to Algorithms in Periods of Volatility

The following was contributed by Curtis Pfeiffer, Chief Business Officer of Pragma

The volatility experienced across the FX market was widely reported during the first quarter of this year. As a result, algorithms (‘algos’) have been utilised by many in the sector to ensure stability in their position and in the execution of their trades during this period.

Curtis Pfeiffer

Traders have been using FX execution algos for several years now, so when the extreme market volatility came about in Q1, they not only knew which algos to use but also how to best use them. One of the big benefits of leveraging execution algos is making a trader more efficient. So, as traders were asked to handle more and larger orders when the markets were volatile, execution algorithms became an indispensable tool, automating trading and allowing users to handle more trades, without sacrificing execution quality.

The inherent benefits of these algos – such as spacing trades out over time and reducing the market impact, became even more apparent to traders during the first quarter of 2020. Since then, there has been a marked rise in their popularity for trading.

The right tool for volatility

During volatile markets, traders often prefer to avoid a price point from one moment in time. It can be better for them to spread an order out over a length of time, not only reducing market impact but also ensuring traders get an average price rather than take the risk of getting a single price at a moment in time – as that single price could be the worst price of the day. Fortunately, execution algos mitigate that risk.

It has been reported, that the FX market has been slow to adopt execution algos in comparison to the equities market; one of the reasons because of this is that there was a belief that they weren’t particularly suited to volatile markets. Pragma challenges this view however – not only due to what is currently occurring in the market but also what clients have to say. Instead, the effectiveness of execution algos have remained the same, if not becoming an even more important tool for traders during periods when markets are volatile and increasingly unpredictable – as was the case during March and early April.

Algorithms are intelligent trading tools that are continually adapting; making them highly suitable to a market that is showing large price movements. It was not the case that algos suddenly became more intelligent or further developed which sparked their popularity; the general nature of execution algorithms makes them beneficial to traders during all periods.

Many of the algorithms that the market uses leverage machine learning and can adapt in a variety of ways a currency pair is traded based upon what the traders’ goals are. Having this adaptability allows for clients to remain agile, taking advantage of small movements during quiet periods and maximizing the opportunities during volatility.

The market moving forward

Once the markets return to some form of normality, which we are beginning to start to see, traders will have even more confidence in using execution algos because they demonstrated their effectiveness to traders in multiple ways during the most volatile markets over the past 10 years. Traders are also expected to continue looking towards customizing their execution algos – which they have more time to do when markets are less volatile – including how the algos should adapt to price behavior or routing preferences to ECNs and other venues.

Algorithms have certainly served their purpose during this period of unprecedented volatility and FX traders are continuing to see why they are not just nice-to-have but a must-have. Moving forward, there will likely be a continued rise in their use, especially as these uncertain times look to set to continue.

The views represented in this commentary are those of its author and do not reflect the opinion of Traders Magazine, Markets Media Group or its staff. Traders Magazine welcomes reader feedback on this column and on all issues relevant to the institutional trading community.