Evolving foreign exchange markets mimic equity cousins

IT’S been quite a rollercoaster in the financial markets over the past few weeks, with everything from indices and equities through to commodities and bond markets all experiencing significant moves. Investors are coming to terms with the prospect of less stimulus from central banks around the globe.

Foreign exchange markets, in particular, have seen some tremendous moves in recent months. The Japanese yen is likely the most striking. The Japanese Prime Minister’s programme of so-called Abenomics had given the yen a one way ticket throughout most of 2013. This lasted until the middle of May, of course. Since then, dollar-yen has seen regular intraday swings of 3 per cent or more.

There is great debate over the future evolution of the FX markets, which face just as many challenges in terms of regulation as other financial markets. Regulators are aware of the expected rise in FX volumes over the next few years. As the global economy continues to grow, and the power of emerging markets increases, the part that FX plays in that growth will be considerable.

Not only do speculators and investors attempt to profit from movements in currency prices, but global corporations hedge their exposures to the many different currencies that they derive their income from.

With electronic trading and a rapid proliferation of new trading venues, the days of the old school close relationships – built up over the traditional telephone broking business – now seem to be long gone.

A little boom area in the City at the moment is the quant hedge fund industry. Both recruiters who specialise in this area, and the brokers that provide their prime services, are seeing a pick-up in business. Ex-bankers are starting up their own mini-funds, and putting to use the proprietary trading skills they used in the past. Many of these strategies involve trading the FX markets to some degree. Even your more traditional buy-side institutions are slowly but surely coming to terms with the potential that FX markets can offer. It can assist in formulating their investment strategies, as currencies are slowly emerging as an asset class in their own right.

The technology involved in many of these platforms now makes execution so fast it’s scary. As such, unconventional strategies like high frequency trading can be used to greater effect. As the demands of investors increase, FX trading will have to continue to evolve by becoming more like its exchange-traded equity, bond and commodity counterparts. It’s likely that we will continue to see providers moving away from the market maker model, and in turn aligning interests with clients.

The number of trades on FX markets still makes up a substantial proportion of the total at Capital Spreads, and there are few signs that this popularity is in any way waning.

Angus Campbell is head of market analysis at Capital Spreads. You can follow him on Twitter @angusjmcampbell

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