As a result, Nomura reports that it has seen average client FX algo volumes quadruple since January 2023, a substantial increase led by increased algo use from real money clients including pension funds and asset managers. The bank also cites survey findings published by Coalition Greenwich which revealed that 69% of respondents believe algo use in FX will increase in the future.
According to Antony Foster, Head of G-10 Spot Trading for EMEA at Nomura, this trend is being driven by relatively calmer FX markets over the past year, which has helped negate the need for clients to call a broker for market colour. At the same time, the FX market has seen a compression in spreads due to competition among banks and market-makers, with Foster also highlighting the fragmentation in liquidity as dozens of electronic platforms host currency trading as an additional factor behind the growth in algo execution. “As markets have become more electronic and fragmented, clients want execution options and analysis to measure their flow rather than charging into the market,” he adds.
Reduced market impact
Ben Robson, EMEA Head of e-FX Sales at Nomura, agrees and adds: “Client conversation around algo usage has evolved over the last decade. It’s no longer seen as a tool to replace traders on the desk but instead augment the set of options around execution and currently it is far more focused on data and the decisions being driven by pre, intra and post trade transaction costs”.
Furthermore, Foster and Robson note that algo trading has increased liquidity by providing continuous bid and offer quotes, making it easier for traders to enter and exit positions. However, they warn that this liquidity can be ‘quite fleeting’ as algorithms can quickly withdraw from the market during periods of volatility. The fragmentation of liquidity across electronic platforms, such as EBS, means a greater need for algos, which smooth out the effects of larger sized orders, they add.
Foster explains that the biggest segment of Nomura’s algo users are asset managers and pension funds, with large spot flow to transact who want to limit market impact while opportunistically taking advantage of market-moving events.
“At times they deploy aggressive algos as these strategies seek out deep liquidity across venues while exploring the likelihood of rejection before intelligently sourcing the right liquidity,” he adds.
With spreads continuing to compress even in very large sizes and banks streaming in bigger notional, there is a huge value in having a conversation with an expert around FX execution, says Robson. He notes that although some banks offer a pre-trade TCA tool, others – including Nomura – prefer to offer a more bespoke service depending on the particular trade.
“Our USP is to offer a tailored response rather than just provide data and leave the client to make decisions without speaking to experts. If volatility kicks off and markets become more complex, clients should utilise the skill of traders using these products daily to inform their decisions,” says Robson.
Driving innovation and growth
The challenge for banks is to take the data that algos are generating and display it to traders on the desk who are deciding what strategies to use, say Foster and Robson. They add that by rapidly incorporating new information into prices, algo trading has contributed to more efficient markets, narrowing bid-ask spreads and increasing the speed of price discovery.
The rise of algo trading has also intensified competition among market participants, driving innovation, with firms investing heavily in developing cutting edge algorithms and technology to gain a competitive edge, leading to continuous improvements in trading strategies and market infrastructure, they observe.
“The growth in algo trading across FX markets represents a significant shift in how currency trading is conducted, and it will only get more sophisticated in future,” says Foster. However, one area of challenge for algos concerns regulatory scrutiny as authorities increase focus on ensuring automated trading systems operate fairly, although according to Foster and Robson, in the long run this will ultimately benefit the development and maturity of the market.
Finally, Foster and Robson believe that the overall outlook for algo trading “could not be brighter” as they predict emerging technologies, such as AI, look set to usher in a new leg of growth. “The integration of AI into algos promises to revolutionise the FX market by enabling the development of more adaptive and predictive models, capable of learning from past data sets,” they conclude.
Among the multiple drivers for the increased usage of algos, Foster and Robson highlighted the following four as significant:
1. Enhance TCA, data and analytics
Banks can now provide data to show that using an algo beats a risk transfer equivalent – such as calling a broker or manually using a platform – over a period of time on average, according to Foster.
Algo trading also reduces transaction costs by minimising the bid ask spread and lowering the market impact of large trades. According to Foster, this cost efficiency is particularly attractive in the FX market where even small cost savings can translate into substantial profits due to high trading volumes.
2. Speed and precision
Human traders cannot match the speed and precision of algorithms, according to Foster and Robson, while algo trading systems can execute trades in milliseconds, capitalising on short lived market inefficiencies and arbitrage opportunities that would be impossible for humans to exploit.
3. Risk management
Advanced algorithms can also monitor and manage risk more effectively than human traders, in addition to dynamically adjusting trading strategies based on real time market data – ensuring positions are hedged appropriately and risk exposure is minimised.
4. Improved automation
The Covid-19 pandemic broadened the use of algos in FX as market participants working from home found it easier to automate their trading.
More information is available at:
https://www.nomuraconnects.com/focused-thinking-posts/the-rise-of-algo-trading-in-fx-markets/
