By working together, computers and people can achieve outstanding results. Modern trading technologies take the burden of executing large FX orders off the shoulders of the corporate treasury department – and achieve impressive outcomes.
As some experienced corporate treasurers know, even in the multitrillion-unit FX markets, a single large position can shift a market price. That’s why, to avoid unfavorable price fluctuations that would increase their hedging costs, seasoned treasury staff often split large-volume orders into smaller trades, or clips.
When doing so, a treasurer is faced with an optimization problem across two fronts: speed and market impact. On one hand, the longer the process lasts, the higher the risk that the market will move against the company mid-order, resulting in the overall price achieved being higher than the initial target price—individual clips have to be large enough to execute the hedge swiftly. On the other hand, each clip should be small enough to make a minimal impact, to avoid influencing the market price, pushing it upward to the detriment of the company.
Finding the optimum
The optimum size of a single clip depends on liquidity in any given market at a given point in time, which can change from one second to another. A perfectly acceptable ticket size in a favorable market environment may already be too big just a few seconds later.
But if market price does not respond to a mid-size clip, this might suggest liquidity is better than expected, allowing the execution to be carried out quickly, in larger portions. If, by contrast, a single ticket suddenly moves the market rate, it might be advisable to take a short break or to proceed with smaller clips.
The optimum execution strategy responds in real time to prevailing market liquidity. The trick is to react blazingly fast to the information you receive from the preceding single orders as they are executed.
Enter the Algorithm
Analyzing information swiftly is the domain of computers. In a structured environment like an electronic market place, a computer is superior to a human in three ways:
- First, it can record and process more information at a time than a human. This means the machine can monitor a larger number of trading venues simultaneously.
- Second, the machine’s response times are shorter. It reacts to changes in market liquidity much quicker.
- Third, the machine does not have any capacity problems when processing a large number of small sub-transactions. A computer can effortlessly initiate 100 single transactions in the space of milliseconds.
Today’s algorithms are advanced to the point where they can remarkably enhance the work of traders. When an FX trader wishes to execute a large position, he or she may choose to deploy an algorithm, rather than breaking up the order manually. In certain market conditions, the algorithm will be hard to beat at executing a large order while making a minimal market footprint.
To harness the power of algorithmic FX trading, I believe a corporate client need only turn to its bank.
“The knowledge and skill of a single trader is no longer the only key to success in FX trading today.”
Instead of paying interest on equity capital to the bank for transferring the market risk, the corporate client smoothly disperses the risk in the market, using the advanced processing power of the algorithm the bank has developed. The knowledge and skill of a single trader is no longer the only key to success in FX trading today. It is the combination of this knowledge with the incredible advances in FX algorithm technology that provide a real advantage to corporate treasurers.
The modern treasurer makes the most of this technological edge and maximizes risk management in a cost-efficient, digitally enhanced way.