Retail and Institutional Markets Converge with FX Algorithms

Brokers are giving savvy retail FX traders access to algorithms, and the buy side is benefiting from the boost in liquidity.

Algorithmic trading has transformed foreign exchange trading. Hedge funds searching for alpha were the first to develop proprietary algorithms and models to trade FX as a distinct asset class, while investment managers seeking liquidity and anonymity in the FX markets are adopting dealer algorithms, according to a recent TABB Group report. But there is another phenomenon shaping FX trading: A new influx of liquidity is originating from retail traders who have access to streaming prices and sophisticated trading tools, helping to boost volumes further.

As online brokers and large banks make foreign exchange trading more accessible to retail traders, algorithmic trading is spreading beyond institutions to tech-savvy individuals, according to Thomas Plaut, CEO of FX Solutions, an Internet-based foreign exchange broker based in Saddle River, N.J., that provides a global trading system that specializes in the top 20 high-volume currency pairs. "We're seeing retail traders now come in building their own models and who are involved in high-frequency trading," he says.

Institutional FX market participants should not underestimate the abilities of retail traders, stresses Plaut, whose firm specializes in delivering non-latent prices to retail traders. "There is this misnomer in the market that retail traders are not good traders -- that there is not smart flow," he observes. But, "It's the exact opposite."

FX Solutions white labels its systems to institutions that include aggregators of retail clients, small hedge funds and commodity trading advisers (CTAs). According to Plaut, his customers are savvy traders who are experienced in trading other asset classes. They are global -- FX Solutions has customers in 120 countries -- they tend to focus on three or four currency pairs and they are active 24-hours a day.

"You have retail traders who have significant programming skills and are highly educated and motivated to do well while access to the market has increased dramatically," Plaut says. In addition, "Transaction costs have decreased, so the playing field has leveled considerably."

Increasingly, foreign exchange trading -- the world's most liquid market, in which the daily turnover is $3.2 trillion, according to the latest Bank for International Settlements report -- has become more accessible to retail traders online. In addition, investment banks are delivering their own liquidity into proprietary portals or into aggregators of liquidity, which makes it easier for retail traders to buy and sell currencies.

According to Todd Crosland, CEO of Interbank FX, a Salt Lake City-based retail FX broker, the retail spot market currently is growing by 50 percent a year and is projected to grow at that rate for the next six to eight years. He says his firm has enjoyed compound annual revenue growth for the last four years of more than 390 percent and now has more than 19,000 customer accounts in more than 135 countries, including traders in Moscow and Beijing.

Interbank FX offers an automated trading system that allows customers to run their own algorithms. The retail trader downloads a program called Expert Advisor from Interbank FX's platform that enables the trader to create his or her own automated strategies. "After you write your strategy, you can back test it," says Crosland, who notes that tick data is saved for the traders.

Some of Interbank FX's retail traders execute 300 to 400 trades a day via an algorithm, which looks at all currency pairs, says Crosland, who adds that Interbank FX awards cash prizes to the most profitable traders on its system each month based on percentage gain. Crosland estimates that 15 percent to 20 percent of the firm's retail clients and 50 percent of the CTAs use automated trading.

Ivy is Editor-at-Large for Advanced Trading and Wall Street & Technology. Ivy is responsible for writing in-depth feature articles, daily blogs and news articles with a focus on automated trading in the capital markets. As an industry expert, Ivy has reported on a myriad ... View Full Bio