Hedge funds, diversification and algos drive boost in FX trading

Worldwide foreign exchange trading volume grew by 36% from 2006 to 2007, continuing a run of double-digit annual growth, according to a new study.
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Worldwide foreign exchange trading volume grew by 36% from 2006 to 2007, continuing a run of double-digit annual growth, according to a new study.

According to consulting firm Greenwich Associates’ 2008 Global Foreign Exchange Research Study, five trends have contributed to the growth: hedge funds, portfolio diversification, algorithmic strategies, retail trading and globalisation.

It said banks and investment managers are increasing their presence in foreign exchange (FX) as they diversify portfolios with international assets, and the market continues to attract new users ranging from hedge fund traders to a growing number of retail investors. Much of this new business, Greenwich said, is being facilitated by electronic trading technology, which provides institutional, corporate and retail players alike with instant access to deep pools of liquidity at very low cost.

“For global FX users, we have entered into an era of something close to free liquidity,” said Greenwich Associates consultant Robert Statius-Muller in a statement. “Cheap access to liquidity from a broad and growing list of sources is drawing in new participants and encouraging users of all types to trade more, which is further adding to global market liquidity.”

The study says that around the world, hedge funds were the biggest driver of growth in FX trading volumes last year. The amount of FX trading volume generated by hedge funds increased some 180% from 2006 to 2007. While hedge funds accounted for just 11% of global volume in 2006, that share jumped to nearly 20% in 2007.

Portfolio diversification also played a role in the growth. FX trading volumes increased by 31% from 2006 to 2007 among investment managers and by 23% among banks, the latter of which account for some 36% of the business worldwide. “Among both groups, an ongoing shift of assets away from the United States and into global and international investments is helping drive the increase in FX trading volumes,” said Greenwich Associates consultant Tim Sangston.

In addition, the spread and advancement of algorithmic trading strategies is giving an important boost to hedge fund trading volumes, according to the study.

“On a global level, hedge funds are, by far, the leading users of algorithmic trading strategies,” says Greenwich Associates consultant Frank Feenstra.

Last year’s 36% increase brings global foreign exchange trading volumes among accounts interviewed by Greenwich Associates to nearly $100 trillion. This follows an increase of nearly 20% in worldwide FX trading volumes from 2005 to 2006 and similar growth the year before.

Growth was strongest last year in the UK, where FX trading volumes jumped some 69% from 2006 to 2007. Volumes increased by about 37% in the Americas and by more than 25% in Continental Europe. Only in Asia excluding Japan, Australia and New Zealand were trading volumes flat year over year.

The market’s steady growth and resilience over the past several years suggest that global FX trading is experiencing a secular expansion rather than a cyclical upturn, the study said.