Big volumes from big banks dominate foreign exchange trading.
The Bank for International Settlements offers the most comprehensive view into the FX market and comes out with a highly anticipated report every three years. The last Triennial Central Bank Survey came out in December 2010.
FX trading represented a $4 trillion business each day, BIS reported. That was a healthy increase from 2007’s $3 trillion a day, according to the study. Spot currency trading was $1.5 trillion a day—up from $1 trillion in 2007. Accordingly, the spot market was 37 percent of all FX products traded. It also accounted for three quarters of the increase in FX trading, BIS reported.
The 2010 survey included outright forwards ($475 billion), foreign exchange swaps ($1.7 trillion), currency swaps ($43 billion), currency options and other foreign exchange products ($207 billion).
The 24/7 FX market is led by London, where 36.7 percent of the volume is traded. New York is next at 17.9 percent, and Tokyo is third at 6.2 percent. Liquidity is best when the London and New York markets are both open. The average trade size is $2 million. The U.S. dollar is involved in one side of 80 percent of the trades, the euro is one side in 46 percent of the trades, the Japanese yen in 20 percent, and the British pound comes in on one side of a trade 14 percent of the time.
In a separate report, Greenwich Associates noted that 61 percent of FX volume traded last year was done electronically. That is up from 57 percent in 2010. Greenwich, which surveyed 1,632 corporate and institutional global customers, describes an electronic trade as one in which communication and settlement is done in a system. So trades over a single-bank or multi-bank platform would qualify, as would trades on ECNs.
According to one FX survey in 2011, dealers remain strong. The top 10 global banks’ market share is 78.76 percent. The top three banks—Deutsche Bank, Barclays and UBS—account for about 37 percent of the business, while the next three—Citi, J.P. Morgan and HSBC—represent about 22 percent.
So the top six banks in the survey equal about 58.5 percent of all trade volume. A Greenwich Associates survey has the same banks in its top six, but in a different order: Barclays, Deutsche, Citi, UBS, HSBC and J.P. Morgan.
The definition of electronic trading in FX is much broader than in equities. Some question whether getting a quote from a bank over a line would qualify as electronic trading—which is different from self-trading and having an order match up in a pool of liquidity.
“Just because you’ve replaced the phone with a FIX connection does not necessarily make it electronic trading,” said Gary Stone, chief strategist at Bloomberg Tradebook. “All you’ve done is replace the phone.”
The Greenwich study also showed 8 percent of respondents traded FX via algorithms last year, compared with 6 percent in 2010. Algorithmic trading among the biggest FX customers—those trading more than $50 billion annually—was high, according to Greenwich. Exactly 16 percent of that group reported using algorithms.
One source said getting the actual volume clients traded with algorithms would be more valuable data, as opposed to the percentage of users. But that is difficult to get. Although someone in the firm has that information, the head trader doesn’t.
“Customers don’t know how much they trade in FX, because they don’t get a commission report every month like in equities,” the source said.
One way to play the electronic trading game is for a trader to break down his trade size to cut down on trading costs. Since each trade is a principal transaction, there is risk involved. So the smaller the trade size, the less the risk and the narrower the quoted spread.
This can lead to savings on trading. For example, suppose a trader wants to buy $100 million of a currency. The old standard on systems was that an investor could trade no less than $1 million at a time. So 100 trades would be the most that trader could execute to equal the $100 million.
But with the advent of ECNs, one trader said he’ll cut his trade size down to $100,000 and make 1,000 trades to get his $100 million done. Time-slicing his order also gives the trader a better chance to achieve his benchmark and with less market impact.
“The smaller the quantity, the higher the probability of getting filled at a better price,” the trader said.
