Forex trading trends you should be aware of

Article by Flextrades:

It’s hard to escape the headlines about forex trading lately. Words such as rigging, currency manipulation, chat rooms and billion dollar fines are grabbing attention and alarming many buy-side customers.

It’s an environment that could give pause to investors, so it’s interesting to note that, in spite of these transgressions, the $5.5 trillion foreign exchange market is growing, driven by new market participants, beyond dealers.

According to the latest Bank for International Settlements Triennial Survey of Central Banks, small banks accounted for 24 % of the turnover, followed by institutional investors such as pension funds and insurance companies at 11%, and hedge funds and proprietary trading firms another 11%.

As such, following are some trends in currency trading that buy-side firms need to be aware of:

1. FX ECNs and Dark Pools

The last 20 years has seen the rise of electronic trading in forex venues, including specialized forex ECN brokers and dark pools.  Venues such as Thomson Reuter’s FXall and State Street’s FX Connect are popular with the buy-side. This gives the buy-side more direct access to electronic trading venues.  In 2014, 75 % of client forex trading was done electronically, slightly up from 74% the prior year, according to Greenwich Associates.  Kevin McPartland, Head of Market Structure Research, says forex is the most electronic market that the firm tracks from a percentage of dollar volume perspective.

2. Exchanges

Exchanges are also jumping into foreign exchange trading, and more could follow. The acquisition of Hotspot by BATS Global Markets for $365 million from KCG is a sign that exchanges are tapping into the demand for more transparency. Other e-forex venues are also attracting new backers. In 2013, BNY Mellon invested in FastMatch ECN, joining Credit Suisse Group and FXCM as partners, suggesting that banks are helping clients capture alternative sources of forex liquidity.

3. Algorithms

As FX trading becomes more electronic, buy side firms are turning to algorithms to execute more sophisticated strategies. The trend is toward more sophisticated trading platforms and trading tools, including algorithms — whether they are supplied by brokers or EMS providers. What’s more, currency-focused hedge funds that use algorithms scored some of the highest gains recently.  Barclay Hedge Ltd reports that hedge funds using computer algorithms to identify market trends earned the highest profits in January.

4. FX Hedging

Buy-side firms are engaging in currency trades to hedge their foreign equities exposures, while others are trading forex as an asset class. A February 2015 Greenwich Associates report shows that 68 percent of equity, fixed-income and forex traders operate in multiple asset classes.  Institutions are also trading in multiple asset classes to generate alpha on their portfolios.

5. Volatility

Volatility has also returned to currencies with the U.S. dollar strengthening against the euro. Since the financial crisis, currency markets have been calm, as central banks moved in a similar direction, making it hard for macro-managers that bet on broad economic movements. But, with the Federal Reserve signaling it plans to raise interest rates, the dollar has jumped against the euro, while the euro has plunged against the dollar due to the ECB’s stimulus program to weaken the currency.  Now that there is a divergence in monetary policies, hedge funds that rely on complex- automated trading strategies are scoring profits. A common strategy is for funds to short the euro against the dollar, though this could backfire if the Fed decides not to raise rates.