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High-Frequency Traders Descend onto Forex Markets

  #9 (permalink)

Edmonton, Canada
Posts: 187 since Apr 2011
Thanks: 12 given, 162 received

Unless the super (do-it-to-the-max) hedge funds all decide to become high frequency sources of bid and ask in "retail" FX, then the impact if any will be negligible at best. If you want to know how the money flows into and out of FX then you will probably want to stay on top of the Triennial BIS Report: http://www.bis.org/publ/otc_hy1011/triensurvstatannex.pdf.

The one thing I noted about the HFT report above, is that it never "defined" HFT from a technical standpoint. Anyone can be HFT, depending on the definition and the truth is retail FX, since the 90's has had what one could call HFTs. What the report did not put into perspective was the relationship to number of trades to notional value. If that analysis had been done, then it would have been clear in the report that: 1) HFT has been in retail FX for quite some time now, and 2) The projected increase for retail FX according to BIS in 2007, would have easily accounted for the influx of these new HFTs.

As you already know, all of FX is OTC. From the Institutional Platforms down to your basic PayPal Bucket Shop FCM, accepting and opening accounts that allow traders to trade with "$1." (I actually ran across a Bucket that advertised this the other day - believe if or not). So, most of the HFT class that the report refers to will have opening balances that will afford them to "trade-up" so-to-speak and onto a either low-end institutional platform (really a high-end FX retail broker), or a straight-up institutional platform using a PM to access a more realistic pool of FX liquidity, that is closer to true Interbank that anything a pure retail FX trader will ever see.

And, that brings up another point. Most (the vast majority) of current retail FX traders who think they are trading "Interbank Rates" because the marketing company disguised as a Retail FX Bucket Shop told them so, have no idea that neither their Bid, nor their Ask, ever sees the light of day in the real Interbank. And, that is because (as you know) all of the FCM/Retail Broker/MM platforms are receiving "dealing rates" through their "dealing desk" (whether they say they have one or not) that come from a proprietary liquidity pool under contract with that FCM or Retail Broker.

Real interbank transactions move in Yards, notional values that are simply beyond the credit reach of the retail FCM crowd. So, they 'make a market' for the smaller retail trader, algorithmically generate their spreads to appear "stable" and promise their proprietary liquidity pool a certain "volume" per day/week/month/year, while on the other hand they promise their customers (retail traders) "guaranteed low spreads and lightening quick STP execution" - which is a totally misleading statement about what's really going on behind the scenes.

This brings up the issue of how the FCM/Retail Broker goes about "off-setting" the trade to their proprietary pool. More like handing-off, than real off-setting, because each one of these guys are basically taking the other side of the trade and acting as counter-party, before any off-set happens - if the truth be told. All the while, the small retail guy thinks that he's really dealing on Interbank. One would need a PM for that, or one would need to become a bank, which is highly unlikely.

However, after saying that - if you look at these proprietary pools under contract with each retail shop, you will note that for the most part they are all eating from basically the same table. Those transactions are just not being centrally housed and there is no central clearing. To demonstrate this, you can go visit the Divisa Capital FX website (a retail FX intermediary) and compare its list of liquidity providers to say, that which you would find on the FXall institutional platform. They share some of the same sources of liquidity, but not under the same contract.

So, I don't expect much impact at all from the influx of HFTs, because I don't expect any of them to go running to their nearest PayPal enabled retail FX broker, which is where they'd have to end up in order to impact the average retail trader. I don't have anything against retail traders, I was one for a very long time and I still have 5% of my funds on a retail platform for other purposes not related to production trading.

I just don't appreciate how the retail side of the business has set out to hurt the smaller traders by using tactics that undermine the success of the retail trader. For the pure retail trader, there are probably only three places they can go to escape most of the Bucket Shop tactics, but I'm almost certain the HFT types the report refers to, won't fit that trader profile and should be able to escape by way of initial starting balance, a I stated earlier.

Nice thread, good question. Cheers!

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