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Global forex markets and high frequency trading

The rise of high frequency trading has pushed forex turnover worldwide to $4 trillion in the first quarter of 2010, up 20% since 2007, a dramatic and unprecedented increase in the global forex market, and almost unimaginable even five years ago. According to the Bank for International Settlements ( BIS) in it’s quarterly review published in December 2010, the main drivers for such explosive growth in global forex markets was as a result of steep falls in trading of many other asset classes.

As quoted by the BIS “against the backdrop of the global financial crisis of 2007-2009, and the recent turmoil in European sovereign bond markets, the continued growth demonstrates the resilience of this market.” The bank confirmed that this recent growth in global forex market trading derived from a broad category known as “other financial institutions” which constituted almost 85% of the increase. The question, of course, is who exactly make up the constituents of this category. Whilst the BIS were unable to drill down into this group in any great detail it was able to reach some broad conclusions and, in particular, one of the key points was that a large percentage of trades are now generated by the world’s largest banks using sophisticated, electronic trading systems which operate at high frequency and on low cost execution. In short as retail traders we are now increasingly trading against highly efficient automated software programmes which are triggering thousands of orders per second, whenever technical signals dictate. As a result these major players are able to provide tight bid/ask spreads to their clients whilst simultaneously squeezing out the smaller, marginal players who are unable to compete either on cost or execution.

The BIS report comes at a key time for the global forex market with high speed electronic trading systems now increasingly under review by the various regulatory bodies, the issues of which were highlighted by last year’s “flash crash” in May in the US equity markets which first prompted an enquiry and demands for greater transparency and a reform of this type of trading. The quid pro quo, of course, is that these high speed systems have made the global forex markets cheaper and more accessible to an increasing audience with lower costs and increasingly liquidity, but everything comes at a price. There is no such thing as the perfect “black box” solution (or free lunch) but as retail traders we now need to be aware that when executing our own trades market direction will increasingly be dictated by the sheer weight of orders triggered by the professional robots. This is a feature which will continue to dominate the global forex markets until the regulators intervene which, of course, may never occur.