Getting the buyside on board with FX algo strategies

June 2023 in Industry Views

Getting the buyside on board with FX algo strategies

FX algos may not exactly be a new product anymore, but pickup within FX still lags equities. Part of this seems to stem from a lack of confidence in FX algo strategies from some client segments.

That of course puts a premium on trust. Without trust, it’s difficult for the client to take the next step and it is therefore vital that the algo provider goes the extra mile to not only provide the right level of detail, but also to ensure that complexity doesn’t overwhelm. It’s a fine line.

This goes for marketing material as well, which is perhaps an area where algo offerings have historically been driven by naming schemes that have focused more on clever branding than on making it easy and clear for the clients to spot the algo that meets their demand.

Exposing more complexity

It is important to always keep in mind that compared to a risk transfer, algos expose more of the complexity of trading in the FX market to the clients. Usage of algos often requires more knowledge about market infrastructure such as technology, liquidity provision and market microstructure that many clients may have been shielded from when transacting using traditional risk transfers. We have decided to take a very active role in sparring with our clients in the use of algos. This includes going through relevant elements of the market microstructure, for example, by introducing the concept of the limit order book to ensure that customers understand the fundamentals of how our algos work.

Drivers of decision to execute trade via algo

Part of what we are aiming at is to demystify the workings of algos. The inner workings of algos need to be provided in a clear and understandable manner to clients, so that they are provided with the level of detail required for them to properly choose and parametrize algos. In that regard, the challenge is to find the appropriate technical level to discuss with clients. This will of course differ somewhat from client to client, but we have found that it is important first to ensure a common ground and terminology in the area of market microstructure.

This includes fundamentals that include, for example, the liquidity provision methods available today and how to use them in the most efficient manner depending on execution objectives. Clients typically know a lot about this landscape from a buy-side perspective already, which means that our focus is on explaining them from the sell-side perspective. This enables them to understand the different types of liquidity pools they can tap into via our algo offering.

It is important to have experts on algorithmic execution participating in client meetings.

It is important to have experts on algorithmic execution participating in client meetings.

Adding value

We consider it important to have experts on algorithmic execution participating in client meetings. We have found that this adds significant value to our clients, both to those that are new to algos but also actually to clients that may already have some experience from using algos but have never really delved into their inner workings. Instead of diving immediately into explaining how algos work and how clients should use them, we think it is important to spend time explaining why we believe they would add value for the client in the first place.

In the end, the goal is to ensure that these meetings are less about pitching a product, and more about educating clients and ensuring that they are adequately equipped to handle the product we are offering. Also, it is good to remember that algos are just a new tool in the toolbox that client have available. This means that use of algos needs to be always evaluated against the other tools to ensure that best execution is guaranteed.

top criteria in algo provider selection

If you stick to treating algos as black boxes, it becomes almost impossible for clients to understand which algo might best suit their use case. Instead, we are trying to expose as clearly as possible the ideas behind each algorithm, which also ensures that algorithms are comparable across our entire algo suite. The challenge is of course to strike a balance between exposing only those details that make a difference for the client. This is part of the reason why we have focused so much on the sparring with the clients. We want to establish a common base with our clients when discussing execution algos. In addition to such face-to-face education and sparring, it is important that all material around algos is easy to understand and is presented in a client-friendly manner, with a clear focus on their needs. To help clients understand the relationship we have divided our algorithms into two main categories: benchmarking and execution optimization algorithms. Further, we have decided to adopt a naming scheme for our algos which closely relates to the trading objective. So, e.g., our passive market-following algorithm is simply called “Make”.

Meeting objectives

We have also adopted a similar decision tree approach as was suggested by BestX in an earlier article in FXAlgoNews in May 2018. Using a series of questions, we try to guide the client towards the algo best suited for their trading objectives. This ensures that clients are taking an active decision to use algos and understand how their decisions affect the algorithm performance. In addition to the decision tree, we find it instrumental to establish a feedback loop between pre-trade and post-trade analysis. This ensures that experiences from earlier executions are used as input for algorithm selection and parameter tuning. We believe that the use of a third-party TCA is paramount in ensuring trust and transparency in the post-trade stage of algorithmic execution.

There is a premium on trust in FX algo trading. Without it clients will find it difficult to take the necessary steps to fully engage with the process.

There is a premium on trust in FX algo trading. Without it clients will find it difficult to take the necessary steps to  fully engage with the process.

In addition to educating clients in algo usage, the issue of trust is also of high importance in ensuring that clients are also comfortable supplying us with enough information about their business and their specific needs, to empower us to best assist them in their choice and parametrization of algo. Or, indeed, advising them to not use an algo, if that is what best fits their particular-use case! In addition to being present on relevant electronic channels, we also still offer a solution where clients can call up our Sales desk and request that they launch an algo on their behalf. This provides us with an opportunity for guiding clients who are not as experienced algo users, and therefore might need more bespoke execution advisory.

Generally, we believe we add value to clients by managing the complexity behind trading on the fragmented FX spot market. This means in practice, management of infrastructure, personnel, algorithms and liquidity connections that make it possible to execute trades efficiently in the FX spot market.