Conventional wisdom among FX trading experts suggests that a high-volume market environment suits a passive algorithmic execution strategy, but analysis by Morgan Stanley shows that the reverse may be the case in today’s market. Since the Swiss National Bank (SNB) removed its minimum exchange rate policy on EUR/CHF in January, the bank has evaluated the performance of its arrival price algorithm, which can be set to varying levels of aggression. The more passive setting has not performed as well since the SNB decision, while the more aggressive setting has remained constant. “This is an ongoing piece of work, but we have found that as volatility has increased, passive algos have become less effective because the market risk they incur by waiting in the market to earn spread is more than outweighing the potential spread that can be achieved,” says Pete Eggleston, head of quantitative solutions and innovations (QSI) at Morgan Stanley.
Recognising concerns that have been raised about the depth of liquidity since the SNB policy decision, Morgan Stanley has also been analysing ‘sweep-to-fill’ costs, which show how much investors would need to pay if they chose to sweep the order book at a certain point in time. By taking data from limit order books, the bank can present its QSI clients with an accurate view of liquidity supply in particular currencies.
“When we look at volumes in conjunction with sweep-to-fill costs, we can get a much more valuable view of liquidity because although there might be a lot of activity in the market, it could be very expensive to trade,” says Eggleston.