The rise of FX algos at Profit & Loss

The Profit & Loss Scandinavia event gathers the Scandinavian FX community and outlines themes, topics and FX products that are surfacing in the industry. This was the 6^th annual event this year held in Stockholm. Participating as a panelist was Nordea Market’s very own Niklas Jahnsson. We caught up with the Algo Quants and Insights expert to learn more.

Nordea Markets: What are currently the hot topics in the FX industry?

Niklas: At the moment, it’s FX algorithms or FX algos for short, dominating the debate. It’s a natural extension and development within the electronic FX trading space. Even though algos have been in existence for quite some time, it has mostly been a tool used for large transactions involving the major currencies as the USD etc.

It still is, but now we are seeing a greater need for tapping into Scandinavian liquidity with FX algos and given and Nordea’s access into that liquidity, it’s a natural step for us to lead the development. However, just providing FX algos or risk transfers to your customer isn’t enough. It’s even more important to be able to prove execution quality (regardless if it is and FX algo or risk transfer being used) and ensure customers are getting the best possible FX trade.

At Nordea Markets we have decided to take a very active role in advising our customers on market microstructure. This includes going through relevant elements of the market microstructure enough so that customers understand the fundamentals of how algos and risk transfers work and indeed why and when they are needed. Our purpose is largely to demystify the workings of algos as we believe this adds significant value to customers, both to those that are new to algorithmic FX trading but also to those that may already have previous experience.

Nordea Markets: What are the benefits of FX algos?

Niklas: Our algo offering answers to our customers need for increased transparency, ease of use and unique access to liquidity in the Nordic FX Market. My experience is also that reduced costs are generally something all customers are looking for, when using FX algos. However, transparency and control are some of the most important features that algos provide to customers when compared to a risk transfer. By using algos you have a possibility to select what kind of market impact their trading behaviour will have.  We see control over market impact as a major differentiator because customers may have a different execution horizon compared to a traditional trading desk that would serve them with a risk transfer. When the long execution horizon is combined on the client side with proper pre- and post-trade analytics, the result can be very different from just doing a risk transfer.

How are Nordea Markets helping customers to reach trading objectives with FX algos?

Niklas: To help pair our customers trading objectives with the right FX algo, we have divided our algorithms into two main categories: benchmarking and execution optimization algorithms. Further, we have decided to adopt a naming scheme for our algos which closely relates to the trading objective. So, e.g., our passive market-following algorithm is simply called “Make”.

Several questions were raised at this year’s event around how data can be used to improve both an individual firm and the wider market functioning?

Niklas: The big difference between traditional risk transfer and execution algos of course is that clients carry the market risk. The choice a customer faces when choosing algos revolve around how to weigh market risk. In some cases, customers aim to execute as fast as possible given that they do not move the market against themselves. Here, pre-trade data analytics play a key role in ensuring that the choice of algo and parameters of that algo make sense in comparison to current market conditions. On the other hand, post-trade data analytics serve the purpose of validating pre-trade input. It is important to stress that doing pre- or post-trade data analysis alone is not enough. One should establish a feedback loop between pre- and post-trade data analytics to be able to learn what is the best way to execute certain trades.

The use of FX algos in the FX spot market seems complex, what is Nordea doing to reduce complexity and improve transparency?

Niklas: We see ourselves as providing value to customers by managing the complexity behind trading on the fragmented FX spot market. This, in practice, means management of infrastructure, personnel, algorithms and liquidity connections that make it possible to execute trades efficiently in the FX spot market. Generally, we are very open about how our whole value chain works when talking to customers to make sure they understand enough to feel comfortable about our offering.

About Profit & Loss

This currency and derivative markets magazine provides unique monthly coverage of both the buy and sell sides of FX and places strong emphasis on analysing strategic shifts and technological advances to ensure readers are equipped with the knowledge for efficient growth.

P&L Services Ltd also runs the highly successful Forex Network and Growth Markets series of global conferences.