Analytical transparency in FX becoming more feasible

ITG says that it believes transparency of trade analysis in the FX market is now possible - beyond the information provided by a single dealer.

ITG says that it believes transparency of trade analysis in the FX market is now possible – beyond the information provided by a single dealer.

The firm has also introduced a free mobile app with the cost of liquidity and a new forward-looking volatility index for 20 currencies, as well as for aggregates such as APAC and emerging markets.

“Getting market color from an increasingly electronic environment is of growing importance, as the surveys show a shift to electronic trading and execution in FX,” said Ian Domowitz, managing director at ITG. “This market colour information translates into actionable decisions and insights on the part of the institutional buy-side, which traditionally viewed FX trading as an operations or custodial function.”

His study titled ‘The cost of liquidity in the FX markets’ has just been published by ITG. He said that the data illustrated in the paper, on the depth of order books, volatility, and cost of liquidity, go a long way in addressing this demand.

The issues that he believes need to be addressed encompass the measurement and control of the FX leg of global equity transactions, which he estimates as being worth between $14 and $40 million a year to a global institution, plus the benchmarking of alternative sources of information.

“Other issues are real time decision support with respect to cost, liquidity, and volatility conditions, plus the ability to measure surprises in the market, which lead to higher transaction costs and potentially to alpha-generating and/or alpha-preserving transactions,” he said.

His research illustrated the use of cost and volatility analytics by examining trading activity during the 2014 World Cup. Such research on the FIFA World Cup has similarities to a European Central Bank study, which used the 2010 event as an experiment to analyse fluctuations in equity investor attention, and to identify market changes due to a behavioural shift. ITG found that the 2014 World Cup also affected attention in the FX market.

In equities, volumes fall, as well as the number of trades in a market for which the home team is playing.

“In FX, the  event is correlated with unusual volatility conditions, differences in liquidity provision, extremes in the cost of liquidity, and even a seeming ignorance of a couple of short squeezes in the making,” said Domowitz.

The results included unusual volatility conditions, differences in liquidity provision as evidenced by the order book, extremes in the cost of liquidity, and even a seeming ignorance of a couple of short squeezes in the making during the game.

His findings from the World Cup results are not definitive, rather illustrative, he says. For example, the timing of volatility spikes after two of the games coincided with two-year U.S. Treasury Bill auctions. However, these spikes are usually not seen at such magnitudes during auctions.

ITG only examined the cost of liquidity. They said that slippage and price impact work awaited a serious look at a cross-section of buy-side firms’ FX dealings, using data with good timestamps.

“Process improvement can lower costs. Trading in EUR/USD, for example, appears to cost roughly three times what we would have predicted based on the order book,” said Domowitz. “For the AUD/USD pair, the factor is four. These are serious numbers, which call for a serious attempt at measurement and analysis.”

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