By James Cochrane

The foreign exchange markets are at an important crossroads. While these markets have benefitted enormously from technology developed over the last two decades, there remains a struggle around the best and most efficient ways to leverage continued technology innovations going forward.

The era of big data has already altered FX. Instantaneous, aggregated trading information makes it possible to see markets all over the world at once and in real time.

All of this new available trading information has been great for currency traders, who can run up as many trading connections as they can reasonably afford and trade electronically in unrestricted currencies nearly continuously. It has had the effect of compressing spreads in the market to very tight levels. Whereas FX trading had an average rate of $100 per $1 million in spread not so long ago, that’s now dropped to between $20 to $25 per $1 million in spread in the more liquid currency pairs.

That’s directly related to electronic trading, showing the huge savings brought to us courtesy of big data. This kind of data access we take for granted today was unheard of 15 to 20 years ago. Electronic trading in FX now accounts for more than half of all trading activity—a number which will only increase in coming years as the fintech boom inspires greater innovation and better connectivity between players. As FX gets more automated, it is finally looking more navigable, thanks in large part to the advent and application of big data-driven technologies. This is a great thing for smaller and mid-sized firms now entering the market in droves, many of them for the first time. In addition to inspiring new ways of connecting to markets, this influx has resulted in waves of consolidation in the industry as indicated by a flurry of recent deals.

But market players shouldn’t be content. This rapid automation of trading systems puts increased power in the hands of money managers and technology tools are a “use or lose” proposition. Big data presents opportunities for FX, as the currency markets still serve as the rough frontier of the trading world. You can find any trade you need if you can connect to the market you want and have access to the most current data to help navigate the complex landscape of currencies. At the same time there is more competition as new players enter the market in the search for alpha on the back of the ever-present volatility.
What big data can do is let an FX trader devise a signal to best take advantage of the market both in times of higher volatility and during more optimal market conditions. The way to establish a winning program is to have the right signal, the right strategies, and the technology in place. Knowing how to use it the right way is a key to longevity in FX. While the “buy low, sell high” paradigm has served many other markets well, the FX markets are a more complex animal and requires the kind of complex construction that big data can provide.

Between interest rates and foreign exchange FX policies by governments and central banks, and the herd-like behavior from the other markets, currency forecasting is extremely frustrating. When the world points to a weakening currency it can wind up strengthening on the back of investor risk appetite. Alpha preservation must also be a focus as well as alpha generation.

That’s why one thing that big data can do is to help us construct a risk appetite index, using the available volatilities of multiple markets to create it. When risk appetite by an investment community is higher, then the attractiveness of a carry trade is greater and it works in the short term. But that can be adjusted when risk appetite is lower. Big data can’t stop bubbles from happening, but using data wisely to build sound strategies is the best way to be prepared for the inevitability of volatility.

James Cochrane is Director and Senior Product Manager for Post Trade and Pre-Trade FX TCA for ITG.

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