Foreign exchange traders are increasingly turning to a new breed of algorithms that can execute transactions smoothly in volatile markets, according to a client report from JPMorgan's trading desk seen by Reuters that covered recent market conditions.
The turmoil wrought by the coronavirus pandemic resulted in market volatility surging unexpectedly and bid-ask spreads on even some of the most actively traded currencies widening to levels last seen during the depths of the 2008 financial crisis.
Clients of JPMorgan looked to so-called adaptive algorithms to give them an edge, leading to the US bank's algos claiming a larger share of its electronic currency trading business, according to the report by the bank's FX electronic trading desk.
The study chimes with Reuters findings that investment banks more broadly have seen a surge in clients trading with "algos" since early March, with the growth eclipsing the broader increase in FX trading volumes.
JP Morgan is the top dealer in electronic FX trading among financial clients, according to a survey by consultancy Greenwich Associates published this month. As such, its business can be viewed as one indicator of the growing popularity of algo trading in the broader $6.6 trillion a day FX market.
More than 60% of trades for ticket sizes of more than $10 million were executed in March via algorithms compared with less than 50% a year ago, the bank's electronic trading desk said.
"The increased challenge of targeting a specific price, an increased market impact risk, an increased client comfort in adaptive algo logic and a decrease in concerns relating to time risk are just a few contributing factors in why adaptive and scheduled orders have become more widely used than limit-based orders," the report said.
Algo usage is a relatively new phenomenon in currency markets, where computer-driven trading has been far slower to catch on than in equities. Only a fraction of trading in currencies is executed via algorithms.
Even in that space, first-generation strategies such as volume-weighted and time-weighted algos were dominant, allowing investors to measure their execution performance by having as little market impact as possible.
Those strategies have ceded ground to adaptive algorithms in recent months, a new generation of sophisticated software that can change trading strategies based on changing volumes, market impact and widening bid-offer spreads.
"Some large banks have a head start in the electronic trading space because of their focus on technology and access to broader liquidity pools," said Satnam Sohal, a principal at Greenwich Associates.
The inroads made by these algos are, however, limited to the most liquid currencies in the world such as the euro, yen and the US dollar, and restricted to the cash markets.
Some large banks like Goldman Sachs are planning to widen their usage in the growing FX swap markets.
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