The turnover in the global FX market is almost ten times larger than in all stock markets combined. However, surprisingly little is known about HFT and algorithmic trading in this space. This webinar will provide insights into some of the unique aspects in this fast-growing market. Session Outline: - Introduction - Overview - What makes FX a unique asset class? - The importance of market conventions - Three dimensions of liquidity - High-frequency and algorithmic FX trading - Some empirical observations - Implications and takeaways Learn more about our EPAT™ course here: https://www.quantinsti.com/epat/ Most Useful links: Visit us at: https://www.quantinsti.com/ Like us on Facebook: https://www.facebook.com/quantinsti/ Follow us on LinkedIn: https://www.linkedin.com/company/quantinsti Follow us on Twitter: https://twitter.com/QuantInsti

1. HFT, liquidity withdrawal and the
breakdown of conventions in FX markets
Dr. Alexis Stenfors
alexis@alexisstenfors.com
30 January 2019

2. Dr. Alexis Stenfors

3. Outline
 Introduction
 Why FX is special
 Conventions
 Liquidity
 The growth of HFT and algorithmic FX trading
 Observations
 Implications and takeaways

4. Why the FX market is special [1/4]
 Large – daily turnover of
$5.067 trillion
 Liquid – even during
episodes of volatility and
stress
 Competitive – zero
commissions and tight bid-
offer spreads
0
1000
2000
3000
4000
5000
6000
World exports
(daily)
FX turnover (daily)
FX market (in $bio)

5. Why the FX market is special [2/4]
 International by definition.
 Perfect symmetry: buy one currency and
sell another.
 Unique link to central banks and states.
Fixed exchange rate regimes (e.g. HK,
Denmark, Saudi Arabia). Others (e.g.
Bank of Japan) occasionally intervene
with a justification that it the market is too
volatile or the exchange rate is
fundamentally ‘mispriced’.

6. Why the FX market is special [3/4]
 Mostly unregulated.
Exempt from the 2010
Dodd-Frank Act and
largely outside the EU-wide
MAR (2016) and MiFID II
(2018).
 No circuit breakers.

8. Why the FX market is special [4/4]
 97.8% over-the-counter (OTC) rather
than exchange-traded.
 Opaque (no exchange or institution
gathering and providing real-time
price and volume data to the
public).
 Relationship-based and largely a
banking activity.

9. Liquidity provision and conventions
 In order to be able to provide liquidity to customers,
market making banks rely on being able to take liquidity
from each other.
 Such conventions act as important stabilisers for the
provision of liquidity in OTC markets.

10. Market liquidity (Kyle, 1985)
 Price-based liquidity: how much does it cost to turn around a
position over a short period of time?
• The bid-ask spread
 Volume-based liquidity: how much can be bought and sold
without moving the price?
• Market depth
 Speed-based liquidity: how long does it take for the price to
recover after a “shock”?
• More difficult to measure and estimate

11. Price-based liquidity conventions
Frequency of indicative 3-month USD/JPY FX Swap spreads 28.05.2009–09.06.2016
Stenfors, A. (2018) Bid-Ask Spread Determination in the FX Swap Market: Competition, Collusion or a Convention?,
Journal of International Financial Markets, Institutions and Money, Volume 54, May 2018, pp. 78–97.
0
100
200
300
400
500
600
700
800
900
0.00 0.10 0.20 0.30 0.40 0.50 0.60 0.70 0.80 0.90 1.00 1.10 1.20 1.30 1.40 1.50
Tullett
Meitan
ICAP

12. Volume-based liquidity conventions
 “Standard amounts” or “reasonable size” in FX markets
have been important in determining how much market
liquidity is acceptable to request, or reasonable to
provide, at the prevailing bid-offer spread.
 Long-term “sense of duty” towards the bank and the
institutional setting of the market (Stenfors 2014).

13. Speed-based liquidity conventions
 “[…] a dealer has to assume that a price given to a
voice/traditional broker is good only for a short length of
time, typically a matter of seconds” (ACI, 2009)

14. Not only about trading profits…
New York Hong Kong Tokyo Singapore
Firm policy N/A 8.6% 12.5% 8.3%
Equitable & reciprocal
trading relationship
56.8% 41.3% 60.2% 44.6%
Market image 30.2% 28.1% 14.8% 28.1%
Trading profits 5.5% 9.7% 5.7% 8.3%
Following major players 4.9% 10.0% 5.7% 10.7%
Other 2.4% 2.3% 1.1% 0.0%
Reasons for following the market convention in the FX market (Cheung & Wong, 2000; Cheung & Chinn, 2001)

15. However…a thing of the past?
 Share on the Electronic Broking System (EBS), the most
widely used electronic FX trading platform, rose from just 2%
in 2004 to 50% in 2010 and 70% in 2013.
 Electronic platforms do not, per se, pose a threat to
conventions. Humans can, and increasingly do,
communicate and interact electronically.
 HFT are neither required nor suitable to follow conventions
made by and for humans.

16. The standard conceptualisation
 HFT are like extremely fast humans.
 This leads to:
• More competition
• Higher efficiency
• Lower transaction costs
• Better price discovery process
• Better liquidity

17. An illusion of liquidity?
 “The market moves as soon
as you try to deal”
 “Liquidity is just an illusion”
 “You can spoof HFT”

18. Approximately 50% non-human
Currency pair EUR/USD USD/JPY EUR/SEK USD/RUB USD/TRY
BIS rank 1 2 11 12 16
Total limit order
amount
€1,818,803,000,000 $1,020,022,000,000 €52,839,000,000 $212,680,000,000 $38,704,000,000
Total market order
amount
€16,793,000,000 $6,518,000,000 - - -
Number of limit
order submissions
1,419,670 787,249 52,839 32,035 38,687
Main platform Yes Yes No No No
Stenfors, A. and Susai, M. (2018) Spoofing and Pinging in FX Markets. Working paper, University of Portsmouth and Nagasaki University.
EBS data from 21:00:00 (GMT) on 8.9.2010 to 20:59:59 (GMT) on 13.9.2010

19. EUR/USD: a first look
Indicator of liquidity
Total limit order amount €1,818,803,000,000
Bid-offer spread (mean) 0.0083%
(median) 0.0079%
Market depth (mean) €16,167,000
(median) €13,000,000
Stenfors, A. and Susai, M. (2018) High-Frequency Trading, Liquidity Withdrawal, and the Breakdown of Conventions in Foreign Exchange Markets, Journal of Economic
Issues, 52 (2), pp. 385-395.

20. EUR/USD: a closer look
Other indicators of market liquidity
Actual transactions (number of executed trades) 9,151
Limit orders / market orders 99.43%
Minimum limit order size €1,000,000
Maximum limit order size €250,000,000
Proportion of small limit orders (€1 Mio) 86.50%
Proportion of split limit orders 15.70%
Limit order lifetime (mean) 44.9 sec
Limit order lifetime (median) 2.5 sec
Stenfors, A. and Susai, M. (2018) High-Frequency Trading, Liquidity Withdrawal, and the Breakdown of Conventions in Foreign Exchange Markets, Journal of Economic
Issues, 52 (2), pp. 385-395.

21. But how quickly is liquidity withdrawn?
 Methodology
• Use the time-stamp of the 1.4 million limit order submissions
as reference points.
• Calculate the change in the limit order volume on each side
of the order book following each new order submission – but
excluding the limit order submission itself.
• Given that HFT can react faster than humans, study different
time windows (0.1, 0.2, 0.5, 1, 5 and 10 seconds)

22. Results
Time (seconds) 0.1 0.2 0.5 1 5 10
Buy (€mio) 0.106 -0.114 -0.932 -0.999 -0.849 -0.835
Sell (€mio) 0.103 -0.135 -0.968 -1.048 -0.769 -0.426
Stenfors, A. and Susai, M. (2018) High-Frequency Trading, Liquidity Withdrawal, and the Breakdown of Conventions in Foreign Exchange Markets, Journal of
Economic Issues, 52 (2), pp. 385-395.

23. A non-technical explanation
 A new limit order submission immediately adds more
liquidity - consistent with the notion that HFT contributes
to market liquidity.
 However, by the time humans have had time to react to
it (or even see it), the new order has already caused
liquidity withdrawal.
 “The market moves as soon as you try to deal.”

24. Former Federal Reserve Chairman Janet Yellen
25 August 2017
“Algorithmic traders […]
are a larger presence in
various markets than
previously, and the
willingness of these
institutions to support
liquidity in stressful
conditions is uncertain”.

25. Limit order strategies linked to perception or
deception
 Split orders: intended to hide market-moving information
 Spoof orders: intended to create a false impression of the
state of the market
 Ping orders: intended to extract hidden information in the
market

26. Using a strict split order definition
i. if the price of limit order submission i is the same as the
price of limit order submission j,
ii. if the direction (i.e. buy or sell) of limit order submission i is
the same as the direction of limit order submission j,
iii. if limit order i and j are submitted within less than 0.1
seconds of each other, and
iv. if no other orders are submitted or cancelled in between
the submissions of limit order i and j.

27. Towards smaller orders, and more frequent order-
splitting
Stenfors, A. and Susai, M. (2018) Spoofing and Pinging in FX Markets. Working paper, University of Portsmouth and Nagasaki University.
0.0%
10.0%
20.0%
30.0%
40.0%
50.0%
60.0%
70.0%
80.0%
90.0%
100.0%
EUR/USD USD/JPY EUR/SEK USD/RUB USD/TRY
Small (I)
Medium (I)
Large (I)
Small (S)
Medium (S)
Large (S)

28. Size versus price aggressiveness
5.00
5.50
6.00
6.50
7.00
7.50
8.00
8.50
9.00
9.50
EUR/USD USD/JPY EUR/SEK USD/RUB USD/TRY
Small (I)
Small (S)
Medium (I)
Medium (S)
Large (I)
Large (S)
Stenfors, A. and Susai, M. (2018) Spoofing and Pinging in FX Markets. Working paper, University of Portsmouth and Nagasaki University.

29. Are markets susceptible to spoofing?
 EUR/USD and USD/JPY highly sensitive to information-rich orders on EBS, but not
EUR/SEK, USD/RUB and USD/TRY.
 Price aggressiveness more critical than size, and split orders designed to prevent
front-running are ‘detected’.
 Spoofing tactics do not necessarily involve large and non-aggressive limit orders (as
per the equity markets literature).
 Spoofing might not be more likely to succeed in illiquid markets.
 Instead, spoofing strategies might evolve very differently depending on the chosen
electronic trading venue.

30. Pinging involves submitting a limit order very fast…
 If nothing happens, the order is immediately cancelled.
 If something happens, the trader extracts ‘hidden’
information from the limit order book, which can then be
taken advantage of.

31. Lifetime of limit order submissions
EUR/USD USD/JPY EUR/SEK USD/RUB USD/TRY
Order type Frequency Lifetime Frequency Lifetime Frequency Lifetime Frequency Lifetime Frequency Lifetime
Small (I) 70.53% 00:39.7 66.82% 01:05.1 100.00% 00:16.2 1.93% 13:21.6 99.80% 00:23.5
Small (S) 15.97% 00:28.8 18.60% 00:50.4 0.00% - 0.01% 00:00.3 0.17% 00:14.8
Medium (I) 10.72% 01:05.2 11.05% 01:51.4 0.00% - 16.49% 00:01.3 0.03% 03:42.6
Medium (S) 1.35% 00:29.0 1.78% 00:41.0 0.00% - 0.19% 00:00.1 0.00% -
Large (I) 1.33% 06:07.8 1.69% 13:22.7 0.00% - 79.81% 00:02.1 0.00% -
Large (S) 0.09% 00:31.0 0.06% 00:51.7 0.00% - 1.56% 00:00.1 0.00% -
All 100.00% 00:44.9 100.00% 01:19.5 100.00% 00:16.2 100.00% 00:17.4 100.00% 00:23.6
PPO 9.54% 00:03.4 10.69% 00:05.3 50.89% 00:08.0 79.89% 00:00.5 20.83% 00:15.3
PPO_0.5 5.25% <00:00.5 5.40% <00:00.5 32.10% <00:00.5 78.03% <00:00.5 4.72% <00:00.5
Stenfors, A. and Susai, M. (2018) Spoofing and Pinging in FX Markets. Working paper, University of Portsmouth and Nagasaki University.

32. Implications and takeaways [1/2]
 Conventions with regards to liquidity provision in FX markets have
traditionally been upheld through reciprocity and trust among
humans.
 Such conventions do not extend to machines and the human
market making function is gradually being crowded out.
 Liquidity might be withdrawn when it is needed the most. Or more
likely: liquidity will be withdrawn when it is needed the most.
 Crucial to use a wide range of metrics to assess FX market liquidity.

33. Implications and takeaways [2/2]
 HFT and algorithmic trading is increasingly associated
with limit order strategies linked to perception or
deception - such as split orders, spoof orders and ping
orders.
 However, their strategic design, prevalence and impact
can be vastly different in FX markets compared to
exchange-traded stock markets.

34. Further reading
 Stenfors, A. and Susai, M. (2018) Liquidity Withdrawal in the FX Spot Market: A Cross-Country Study Using
High-Frequency Data, Journal of International Financial Markets, Institutions & Money (forthcoming).
 Stenfors, A. and Susai, M. (2018) High-Frequency Trading, Liquidity Withdrawal, and the Breakdown of
Conventions in Foreign Exchange Markets, Journal of Economic Issues, 52 (2), 385-395.
 Stenfors, A. (2018) Bid-Ask Spread Determination in the FX Swap Market: Competition, Collusion or a
Convention?, Journal of International Financial Markets, Institutions & Money, 54, 78-97.
 Stenfors, A. and Susai, M. (2018) Spoofing and Pinging in FX Markets. Working paper, University of
Portsmouth and Nagasaki University.
 Stenfors, A. and Susai, M. (2019) Stealth Trading in FX Markets. Working paper, University of Portsmouth
and Nagasaki University (forthcoming).

35. Thank you!