High-frequency trading (HFT) has become a significant part of the foreign exchange (FX) market, with HFTs accounting for 30-35% of FX trading volume. HFT strategies in FX include arbitrage between currency prices on different platforms, reacting rapidly to news events and economic data releases, and providing liquidity. While HFTs have increased market liquidity and narrowed spreads under normal conditions, their ability to rapidly withdraw liquidity in times of market stress has raised concerns. The growth of HFT in FX shares some similarities but also differences compared to HFT in equity markets.

1. High-Frequency TradingHigh-Frequency Trading
in the FX Marketin the FX Market
Yoshiharu SatoYoshiharu Sato
University of Warsaw, 2015University of Warsaw, 2015
(https://sites.google.com/site/yoshi2233/)(https://sites.google.com/site/yoshi2233/)

2. FX Market StructureFX Market Structure
・・ Before 1990's, the FX market was predominantly a broker-Before 1990's, the FX market was predominantly a broker-
dealer market restricted to large financial institutionsdealer market restricted to large financial institutions
・・ Most transactions took place in the inter-dealer core of thisMost transactions took place in the inter-dealer core of this
market, and customers were able to trade only in the outermarket, and customers were able to trade only in the outer
tier of this market with wider spreadstier of this market with wider spreads
・・ Requests for quotes and transactions were typically doneRequests for quotes and transactions were typically done
over the telephoneover the telephone
・・ Advent of electronic broking/trading in 1990's broughtAdvent of electronic broking/trading in 1990's brought
about a revolution in the inter-dealer market, still theabout a revolution in the inter-dealer market, still the
boundary between the core and customers remainedboundary between the core and customers remained

3. FX Market StructureFX Market Structure [1][1]

4. FX Market Structure (cont.)FX Market Structure (cont.)
・・ In early 2000's, the boundary between the market core andIn early 2000's, the boundary between the market core and
customers blurred as FX dealing banks started offeringcustomers blurred as FX dealing banks started offering
electronic trading services to clients. Today the market haselectronic trading services to clients. Today the market has
become less dealer-centric, to the point where there isbecome less dealer-centric, to the point where there is
no longer a distinct inter-dealer-only marketno longer a distinct inter-dealer-only market
・・ The FX market is now a huge decentralized OTC marketThe FX market is now a huge decentralized OTC market
with $5.3 trillion turnover a day, trading 24h/5days a week.with $5.3 trillion turnover a day, trading 24h/5days a week.
70% of the spot currency volume is now algorithmic, and70% of the spot currency volume is now algorithmic, and
30-35% of the volume is by HFTs [2]30-35% of the volume is by HFTs [2]
・・ Currency volume shares: USD 85%, EUR 40%, JPY 20%,Currency volume shares: USD 85%, EUR 40%, JPY 20%,
GBP 13%, AUD 8%, CHF 7%, etcGBP 13%, AUD 8%, CHF 7%, etc

5. FX Market Structure (cont.)FX Market Structure (cont.) [1][1]

6. FX Market Structure (cont.)FX Market Structure (cont.) [2][2]

7. Advantages of FX HFTAdvantages of FX HFT
・・ The highly liquid, 24h open FX market is ideal for HFT,The highly liquid, 24h open FX market is ideal for HFT,
which requires a liquid underlying market in order towhich requires a liquid underlying market in order to
make profits from a large number of small tradesmake profits from a large number of small trades
・・ Co-location (i.e. HFTs moving their servers as close asCo-location (i.e. HFTs moving their servers as close as
possible to the trading venue) allows HFTs to trade withpossible to the trading venue) allows HFTs to trade with
latency of less than 1 millisecond, compared with 10-30mslatency of less than 1 millisecond, compared with 10-30ms
for most non-HFT participantsfor most non-HFT participants
・・ HFTs can therefore react very quickly to various profitHFTs can therefore react very quickly to various profit
opportunities that exist in the FX marketopportunities that exist in the FX market

8. Who are FX HFTs?Who are FX HFTs?
・・ HFTs in the FX market are mostly proprietary trading firms,HFTs in the FX market are mostly proprietary trading firms,
some of which have evolved from HFT in equities. Otherssome of which have evolved from HFT in equities. Others
have been developed by existing FX specialists that havehave been developed by existing FX specialists that have
decided to move into the HFT spacedecided to move into the HFT space
・・ FX HFTs concentrate in Chicago, New York and LondonFX HFTs concentrate in Chicago, New York and London
(where co-location facilities are primarily located) and(where co-location facilities are primarily located) and
trade mainly on inter-dealer electronic platforms (EBS,trade mainly on inter-dealer electronic platforms (EBS,
Reuters) and ECNs (e.g. Currenex, Hotspot, Fxall)Reuters) and ECNs (e.g. Currenex, Hotspot, Fxall)
・・ Since HFTs typically access the various platforms via theirSince HFTs typically access the various platforms via their
prime brokers, other participants can usually see only theprime brokers, other participants can usually see only the
prime brokers’ names and not their clients’ namesprime brokers’ names and not their clients’ names

9. Who are FX HFTs? (cont.)Who are FX HFTs? (cont.)
・・ FX HFTs tend to focus on spot of the most liquid pairsFX HFTs tend to focus on spot of the most liquid pairs
・・ Larger FX HFTs are the predominant source of interbankLarger FX HFTs are the predominant source of interbank
liquidity in the FX market and tend to trade on EBS/Reutersliquidity in the FX market and tend to trade on EBS/Reuters
・・ Smaller FX HFTs prefer ECNs due to lower minimum tradeSmaller FX HFTs prefer ECNs due to lower minimum trade
size, less trading controls, and full anonymitysize, less trading controls, and full anonymity
・・ Since HFT strategies require a diverse, information-richSince HFT strategies require a diverse, information-rich
(multi-bank, multi-price) environment, many FX HFTs trade(multi-bank, multi-price) environment, many FX HFTs trade
on multiple platforms for greater market coverage andon multiple platforms for greater market coverage and
circumventing certain platform constraints (e.g. number ofcircumventing certain platform constraints (e.g. number of
quotes that can be submitted per second)quotes that can be submitted per second)

10. FX HFT StrategiesFX HFT Strategies
・・ Classic arbitrage: exploits the difference between theClassic arbitrage: exploits the difference between the
market price and the implied no-arbitrage pricemarket price and the implied no-arbitrage price
(e.g. triangular arbitrage)(e.g. triangular arbitrage)
・・ Latency arbitrage: exploits the small time lag betweenLatency arbitrage: exploits the small time lag between
when market-moving trades take place and when market-when market-moving trades take place and when market-
makers update the prices they quotemakers update the prices they quote
・・ Liquidity-providing: earns a spread by exploiting orderLiquidity-providing: earns a spread by exploiting order
book imbalances for a particular currency pair and pricingbook imbalances for a particular currency pair and pricing
discrepancies across trading platformsdiscrepancies across trading platforms
・・ Complex event processing: exploits various propertiesComplex event processing: exploits various properties
such as momentum, mean-reversion, correlation (withsuch as momentum, mean-reversion, correlation (with
other currency pairs or with other assets) and responseother currency pairs or with other assets) and response
to economic data releasesto economic data releases

11. Event Reaction – ExampleEvent Reaction – Example [3][3]

12. Event Reaction – ExampleEvent Reaction – Example [4][4]

13. Event Reaction – ExampleEvent Reaction – Example [5][5]

14. FX HFT Strategies (cont.)FX HFT Strategies (cont.)
・・ The majority of HFT strategies are designed to benefit fromThe majority of HFT strategies are designed to benefit from
high liquidity and low volatility. Hence there is a tendencyhigh liquidity and low volatility. Hence there is a tendency
for HFTs to avoid illiquid currency pairs and reduce tradesfor HFTs to avoid illiquid currency pairs and reduce trades
when volatility riseswhen volatility rises
・・ Given their high-volume, low-margin trading style, HFTsGiven their high-volume, low-margin trading style, HFTs
typically are highly sensitive to the impact of even smalltypically are highly sensitive to the impact of even small
trading errorstrading errors

15. HFT Impact on FX MarketHFT Impact on FX Market
・・ Due to the intense competition brought about by HFTs,Due to the intense competition brought about by HFTs,
spreads has been narrowed and liquidity has beenspreads has been narrowed and liquidity has been
increased in normal market conditionsincreased in normal market conditions
・・ Price behavior has become more granular, with fewer bigPrice behavior has become more granular, with fewer big
moves and gaps than inmoves and gaps than in the days of manual-only tradingthe days of manual-only trading
・“・“ Increased liquidity” is still debatable – HFTs send largeIncreased liquidity” is still debatable – HFTs send large
numbers of orders and cancellations (i.e. quote stuffing),numbers of orders and cancellations (i.e. quote stuffing),
and their orders appear simultaneously in multiple tradingand their orders appear simultaneously in multiple trading
venues but disappear across venues as soon as one ofvenues but disappear across venues as soon as one of
them is hit (a.k.a. liquidity mirage)them is hit (a.k.a. liquidity mirage)

16. FX HFTs during Flash CrashFX HFTs during Flash Crash
・・ On May 6, 2010 (Flash Crash), algorithmic tradersOn May 6, 2010 (Flash Crash), algorithmic traders
(including HFTs) comprised 53.5% of total activity in FX,(including HFTs) comprised 53.5% of total activity in FX,
which was higher than 2010 average of 45%which was higher than 2010 average of 45%
・・ This suggests that FX HFTs did not reduce activity duringThis suggests that FX HFTs did not reduce activity during
the Flash Crash unlike equity HFTs, who paused tradingthe Flash Crash unlike equity HFTs, who paused trading
and caused the liquidity in the equity market evaporatedand caused the liquidity in the equity market evaporated

17. FX HFT vs Equity HFTFX HFT vs Equity HFT

18. FX HFT vs Equity HFT (cont.)FX HFT vs Equity HFT (cont.)
・・ They both tend to focus on the most liquid market segmentThey both tend to focus on the most liquid market segment
- Index futures, ETFs, blue-chip stocks- Index futures, ETFs, blue-chip stocks
- EUR/USD, USD/JPY, GBP/USD- EUR/USD, USD/JPY, GBP/USD
・・ They have similar impact on marketsThey have similar impact on markets
- Narrower spreads- Narrower spreads
- Smaller quote size, shorter quote life- Smaller quote size, shorter quote life
- Shorter holding time, more frequent trades- Shorter holding time, more frequent trades
・・ They raise common concernsThey raise common concerns
- Liquidity mirage- Liquidity mirage
- Hot-potato trading volume- Hot-potato trading volume
・・ FX HFT is increasing in trade volume sharesFX HFT is increasing in trade volume shares
while equity HFT has decreased due to scrutinywhile equity HFT has decreased due to scrutiny

19. FX HFT vs Equity HFT (cont.)FX HFT vs Equity HFT (cont.)
・・ Rebate arbitrage – a prevalent HFT strategy in equitiesRebate arbitrage – a prevalent HFT strategy in equities
・・ Local exchanges offer rebates to liquidity providersLocal exchanges offer rebates to liquidity providers
(passive limit orders) while charging liquidity takers(passive limit orders) while charging liquidity takers
(active market orders) a.k.a. the Maker-Taker model(active market orders) a.k.a. the Maker-Taker model
・・ The HFT captures the rebate fee each time an order resultsThe HFT captures the rebate fee each time an order results
in a passive trade, regardless of whether the trade makesin a passive trade, regardless of whether the trade makes
profits or not. But if the HFT trades actively to reduce aprofits or not. But if the HFT trades actively to reduce a
position by either hitting a bid or lifting an offer, it does notposition by either hitting a bid or lifting an offer, it does not
obtain the rebateobtain the rebate
・・ This type of pure market-making HFT strategy is so far notThis type of pure market-making HFT strategy is so far not
prevalent in FXprevalent in FX

20. FX HFT vs Equity HFT (cont.)FX HFT vs Equity HFT (cont.)
・・ Latency arbitrage – another HFT strategy in equities madeLatency arbitrage – another HFT strategy in equities made
prevalent by the 2005 SEC Regulation NMS, which requiresprevalent by the 2005 SEC Regulation NMS, which requires
brokers to execute each customer trade at the nationalbrokers to execute each customer trade at the national
best bid or offer price (NBBO) across all US equitybest bid or offer price (NBBO) across all US equity
exchanges at that given momentexchanges at that given moment
・・ The time lag between the appearance of bids/offers on theThe time lag between the appearance of bids/offers on the
raw price feeds from various exchanges and the posting ofraw price feeds from various exchanges and the posting of
the NBBO on consolidated data feeds provides a potentialthe NBBO on consolidated data feeds provides a potential
arbitrage opportunity for HFTsarbitrage opportunity for HFTs
・・ This exists in FX, but there is no equivalent of NBBO andThis exists in FX, but there is no equivalent of NBBO and
latencies are less predictable as FX is decentralized withlatencies are less predictable as FX is decentralized with
less transparency than equitiesless transparency than equities

21. ConclusionsConclusions
・・ FX HFT originated from equity HFT. It is important toFX HFT originated from equity HFT. It is important to
understand the commonalities and differencesunderstand the commonalities and differences
・・ HFTs are normally beneficial in providing liquidity andHFTs are normally beneficial in providing liquidity and
narrowing spreads, but given its sensitivity to risk, HFTnarrowing spreads, but given its sensitivity to risk, HFT
liquidity may evaporate rapidly in stressed circumstancesliquidity may evaporate rapidly in stressed circumstances
・・ HFT is an embodiment of the operational advantage gainedHFT is an embodiment of the operational advantage gained
by superior technology. Once this advantage has beenby superior technology. Once this advantage has been
gained, it is difficult for others to compete away thisgained, it is difficult for others to compete away this
advantage, given the large investment required to replicateadvantage, given the large investment required to replicate
the technologythe technology

22. ReferencesReferences
[1] Bank for International Settlements, “High-frequency trading in the foreign[1] Bank for International Settlements, “High-frequency trading in the foreign
exchange market,” 2011.exchange market,” 2011.
[2] Bank for International Settlements, “The anatomy of the global FX market[2] Bank for International Settlements, “The anatomy of the global FX market
through the lens of the 2013 Triennial Survey,” 2013.through the lens of the 2013 Triennial Survey,” 2013.
[3] https://twitter.com/nanexllc/status/608778936743522304[3] https://twitter.com/nanexllc/status/608778936743522304
[4] https://twitter.com/nanexllc/status/611503435205054465[4] https://twitter.com/nanexllc/status/611503435205054465
[5] https://twitter.com/nanexllc/status/611672061732257792[5] https://twitter.com/nanexllc/status/611672061732257792

23. ThanksThanks