May 26, 2010

Richard Tibbetts
Algorithmic trading in FX is on the rise. Last year StreamBase’s annual FX trading and technology survey revealed that around a third of active FX traders were using algo strategies; this year the number increased to almost half with still more planning to add this capability in the near future.

As algo trading in FX becomes the dominant method for finding trading opportunities and accessing liquidity in the fragmented FX market, there are a number of changes occurring at both sell- and buy-side firms. Sell-side firms are under pressure to supply innovative eFX platforms that offer tighter spreads, greater product range, more sophisticated user interfaces, and that allow for new products to be added as soon as they become available to trade electronically.

The larger and more established FX venues that enjoy the vast majority of order flow are seeing increased competition from smaller and more recent FX operators seeking to increase their market share.

These rising FX providers are proving to be nimble market participants that are not encumbered by legacy technology infrastructures and are ready to innovate.

Aggregation of FX information is a key driver for algo trading. Whereas buy-side firms want to aggregate FX, sell-side firms are wary of being aggregated into a single platform, but it’s hard to resist. More and more buy-side firms are seeking to aggregate prices and liquidity across multiple markets.

Why is this? It may seem obvious, but let’s look at our survey results: the primary reason is in order to locate automated trading opportunities, second to use for their own smart order routing systems, and thirdly in order to determine reference pricing.

Next let’s look at how the aggregation takes place. The survey results indicate that there is a 50:50 split between those using a single platform to aggregate and those using multiple broker dealer platforms to manually aggregate and trade across multiple systems.

We have certainly come across firms where FX aggregation consists of a trader manually performing the task thanks to a quick mind and lightening fast computer skills, but more and more firms we meet with seek to connect to a single platform for aggregation, and we only expect this to increase over time.

Aggregation is similarly an issue for the sell side faced with offering competitive pricing to their clients who are becoming more sophisticated in their FX decision making. FX aggregation systems need to address the issues inherent in normalization, analysis, and venue connectivity – and as the number of liquidity providers continues to grow, the lack of standardization and uniform semantics adds more pressure on technologists to utilize flexible and rapid time-to-market technologies for building their underlying platforms.

As the FX market becomes increasingly aggregated and algo trading becomes more prevalent, speed will likely determine who the true winners and losers are, particularly in terms of alpha generation and order execution.

In equities absolute speed is a requirement, but in the FX market with no central exchange there is still considerable potential for firms to gain competitive advantage by reacting faster to the market with more advanced technology and infrastructure than their competition.

No wonder over 60 percent of our survey responders are interested in learning more about how CEP can be used in FX.

Richard Tibbetts is a co-founder and Chief Technology Officer at StreamBase Systems. He earned both his BS in Computer Science and Engineering, and Masters of Engineering Degrees at MIT.