ALGORITHMIC FX TRADING
Opportunistic FX algorithms -
striking the right balance with trade execution strategies
Nicholas Pratt examines how opportunistic third generation FX algorithms can now provide firms with more effective implementation of their trading strategies.
T
he use of a term like ‘third generation’ can be fraught with danger, akin to being the Chancellor of the Exchequer in the middle
of a recession and telling the population that you are seeing “the green shoots of recovery”. If these shoots appear, you may well look like a genius blessed with foresight and be credited for your vision. If, however, the green shoots take an age to appear, it will take even longer for the disdain and mockery to die down.
Early iterations
Similarly if you talk of the arrival of a ‘third generation’ of something as new as FX trading algorithms, there is the risk that some observers will feel they are yet to see the full development of a first generation, you may run the risk of ridicule. However, putting all these risks aside, it is clear that the development of FX algorithms has certainly moved on from those initial trading tools that merely swept the market in search of liquidity and presented an aggregated picture of the gathered liquidity.
We then saw a second stage of development that saw the arrivals of execution algorithms which were able to take a series of orders and then execute them periodically over the course of a day based on pre- defined rules and conditions. Typically these rules
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would be based on the time of day, as in a time weighted average price (TWAP) algo, or the volume of the order, as in the volume weighted average price (VWAP). And the objective of these trading strategies was to slice and dice an order into smaller and less detectable sizes so that a trading firm’s market impact could be minimised.
Third generation
Te third generation of algorithms refers to the emergence of more opportunistic algorithms that are able add a decision-making process on top of all the automated, rules-based properties and actions. “It is about a much more complex area of inter-algo co- ordination,” says Joey Horowitz, director of software development for Dealing Aggregator at Tomson Reuters.
One of the challenges for third generation algorithms is to strike a balance between the two properties of an algorithm that are often seen as diametrically opposed – the speed of execution and the minimising of market impact. How can the characteristics of the latest wave of FX algorithms help to strike that balance between the two? “It is not an easy thing to achieve in the FX marketplace because there is a great deal of execution complexity underneath the algorithms,” says Horowitz. “Speed of execution or minimising market impact are normally provided by most good algorithms but the ability to decide whether or not to use the standard algorithm is where opportunistic algorithms really come into their own.”
Tis action has been encouraged by the market, says Horowitz. “Te market is now providing channels that
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