1. Trade Size – Risk Management

Having the ability to trade small position sizes assists traders to manage risk better for smaller accounts and gives larger clients more granularity when scaling in and out of positions. FXCM clients can place trades as small as 1,000 currency units where the value of 1 pip is worth $0.10. Compare this to the futures market where the most liquid, standard Euro Futures Contract (6E) size is 125,000 Euros.

E-Micro and E-Mini contracts are available for trading in the futures markets, but liquidity is generally very thin in these markets. The average daily notional E-Micro trading volume makes up only 0.5% of total EUR/USD futures volume and E-Mini trading volume makes up only 0.9% of total EUR/USD futures volume.

The following table displays the average daily notional trading volume for the E-Micro (M6E), E-Mini (E7), and Euro Futures (6E) contract from November 10, 2015 to December 8, 2015.

8-Reasons-to-Build-Your-Algo-to-Trade-FX-vs-Futures-or-Equities_body_Picture_30
Source: CME Group[1] [2] [3]

If you plan on trading a diverse basket of instruments, the challenges of dealing with larger contract sizes become even more difficult. One of the only ways you could reduce risk when trading a large contract is by moving your stops closer, which may not be the best outcome for your strategy.

With equities, you can trade in increments as little as 1 share, so your restraint on trade size there could be the price of the stock you are trading.

2. Ease of going short

When trading equities, you may have a few hurdles to deal with if you plan on going short in your strategy. The first is that you generally must borrow the stock from your broker, if available, potentially at annualized interest rates that can reach up to 100% on some hard to borrow stocks. If you receive a forced buy-in, you may have to cover your short without notice in a short squeeze.

If the SEC mandated circuit breakers ever kicked in, you may not be able to go short in any stock due to the alternative uptick rule.

In both FX and Futures, you can sell short on both an uptick and downtick and there are no interest payments required for going short. The only financing that comes into play with FX is rollover, which is based on the difference in overnight lending rates between the two currencies. For this reason, you can actually earn rollover on some pairs when going short.

3. Instrument Universe

In the US alone, there is somewhere around 25,000 listed and delisted stocks available for analysis. Just focusing on the listed stocks may introduce selection bias to your strategy.

A diversified futures portfolio can trade well over 100 instruments, not to mention the varying contract months available for each instrument. However, in the FX market, 8 pairs make up 72% of all FX volume. This can potentially simplify your strategy development process.

4. Leverage – Position sizing

Let me start by saying that leverage is a double-edged sword which can magnify both your gains AND your losses.

In the equities market, to trade with leverage, you generally must borrow the funds from your broker in the form of a line of credit with annualized rates typically varying based on your balance. In order to trade with leverage in stocks a margin account would be required. Margin accounts may offer clients 2:1 leverage and some may offer 4:1 intraday leverage.

In the futures and FX markets, you pay no interest for leverage as position margins are performance bonds and the leverage available to market participants can be considerably higher.

For the sophisticated algo trader, leverage can be an effective utility that allows you to spread out your risk across more instruments or use risk based position sizing where risk per trade is determined by stop loss placement. When trading equities this way, you may find that you do not have enough purchasing power to purchase the number of shares determined by your strategy.

Consider the following example. You have $10,000 and are willing to risk 10% of that across 5 stocks by setting your stop 5% away from the current market price. In order to do this, you would need to have more than double the purchasing power of the account, which would require a line of credit with your stock broker. The tighter your stops or the higher your risk budget, the more purchasing power that would be required.

8-Reasons-to-Build-Your-Algo-to-Trade-FX-vs-Futures-or-Equities_body_FXvsfuturesorequitiespicture0
5. No Pattern Day Trader Rule




If you plan on trading an intra-day strategy in the US equities market, you will need to have a minimum of $25,000 in your account if your trading falls under the scope of the rule.

There is no similar rule for futures or FX trading.

6. Liquidity

Liquidity reflects the amount and frequency of trading in an underlying asset class or instrument. According to the Bank for International Settlements’ Triennial Survey, trading in foreign exchange averaged $5.3 Trillion per day in April 2013 [4]. More recent figures are not available as the report is done once every 3 years.

The total 5 day average daily volume for US Stock Exchanges by comparison is $7.9 billion by comparison.[5] One challenge Ernie Chan mentions in his last book[6] is that NBBO (National Best Bid and Offer) quote sizes have become very small. He thinks this is perhaps due to dark pools, iceberg orders by institutional traders, or HFTs. If the NBBO quote is only 100 shares and you are trying to get a fill for 5,000 shares, you might not get the price you expect.

The CME reported an average daily volume of 13.8 million contracts per day in April 2016 across all of their products.[6] The futures market has excellent liquidity in many contracts; however, retail traders must compete against HFTs and institutional traders for the best available pricing. See reason number 8 for more on this.

7. Market Participants

Most participants in the stock market are generally profit seeking, meaning few participants use the stock market to hedge risk related to their underlying business. Investors usually allocate capital to the most promising companies in expectation of benefitting from future cash flows. Speculators also participate, who are profit-seeking, but with a shorter holding period compared to investors.

The FX market is composed of investors and speculators as well, but large banks and corporations can participate as hedgers, with no intention of earning a profit on their trades. Their goal when hedging is to lock in a rate and transfer market risk to speculators. Governments and Central Banks also operate in the FX market, but their goals are not to maximize profits on the trade, rather to stimulate growth in their economies.

The futures markets also have many hedgers as market participants, seeking to lock in a rate for their crop for example, and transfer market risk to speculators in the process.

In summary, the FX and Futures markets generally have a large number of participants seeking to transfer risk instead of using the markets for profit-seeking trades. Speculators provide liquidity and the successful ones can profit from this exchange with the right strategies.

8. Competition with HFTs

Both stocks and futures are traded on a central exchange which means that retail traders, institutions, and HFTs are all competing with each other for liquidity. The fastest high frequency traders may be in and out of trades in just microseconds, spending millions of dollars on technology to be the fastest market maker possible. This speed race makes the institutional environment very competitive and predatory on slower participants.

The Spot FX market is an Over the Counter (OTC) or off-exchange market, which means there are multiple venues and brokers offering bespoke liquidity pools.

For familiarity and brevity’s sake for this article, I’m just going to discuss FXCM’s No Dealing Desk (NDD) forex execution as I believe an NDD model offers one of the best trading environments for the retail FX trader due to depth of liquidity and tight spreads.

FXCM’s NDD execution engine offsets every trade one for one with our liquidity providers, eliminating the hedging problems scalping creates for the typical retail market maker and giving the retail trader anonymity and no restrictions on trading style. With FXCM’s NDD execution engine, liquidity providers do not have to constantly worry about predatory high frequency trading because the liquidity providers are only allowed to take orders from retail clients.

This creates a safer environment for liquidity providers to offer tighter pricing and deeper liquidity without fear of being picked off by another liquidity provider’s high speed algo.

The liquidity provider whose quote gets taken by a retail trader receives confirmation of the trade before other market makers which gives them an information edge over its competitors. This creates an incentive for FXCM’s liquidity providers to provide the best pricing possible for our retail clients in order to capture order flow which can be factored into their institutional market making algorithm to gain an edge on their competitors.

FXCM also requires that liquidity providers adhere to strict standards for order rejection rate, spreads, quoting prices, and latency. Those providing the best pricing and execution according to these rules will gain an advantage over other market makers which could result in a 20-30% increase in orders captured. Market makers who cannot meet these standards are sent to the end of the line and could be removed from the platform until they do.

Liquidity Providers accept these high standards in order to gain access to retail market data obtained when executing orders and an additional venue to hedge and offset their own orders.

A market maker allowing an order to sit for too long, for too good of a price, or for too much liquidity is likely to be picked off by other participants if they’re wrong. The safest play for market makers to take is to quote smaller sizes at wider prices to minimize their risk.

Additionally, the simple act of hedging sizeable volume at institutional venues can create very fast, directional moves. As market makers execute additional trades in the same direction, other participants use algos keyed into these trading patterns resulting in them going in the same direction as the hedger.

The result can be costly for the market maker attempting to execute large orders in the market. To avoid this costly scenario, market makers will often ‘skew’ or quote extremely tight spreads to retail traders in order to be the top of book and get all of the flow from FXCM’s retail traders. This can result in choice pricing (0 spread) in major pairs like EURUSD and USDJPY for retail traders.

Algo traders holding trades for a few seconds or longer would be ideally suited for FXCM’s pricing. FXCM’s liquidity providers see all orders as coming through from FXCM; however, traders putting through large order sizes should be strategic with order placement. If, for example, a trader intends to put on a total trade size of 100 million and is entering orders of 5 million in a continuous fashion, liquidity providers may recognize a pattern.

In conclusion, while I strongly believe in a diversified approach using robust algo strategies across as many asset classes as possible, the spot FX market may offer the retail algo trader many unique benefits not found in any other market.

Questions, comments and feedback are welcome. Drop me a line at bfletcher@fxcm.com.

To join my email distribution list, please fill out this form.

Any opinions, news, research, analyses, prices, or other information contained on this website is provided as general market commentary, and does not constitute investment advice. The FXCM group will not accept liability for any loss or damage, including without limitation to, any loss of profit, which may arise directly or indirectly from use of or reliance contained in the trading signals, or in any accompanying chart analyses.

Links to third-party sites are provided for your convenience and for informational purposes only. FXCM bears no liability for the accuracy, content, or any other matter related to the external site or for that of subsequent links, and accepts no liability whatsoever for any loss or damage arising from the use of this or any other content. Such sites are not within our control and may not follow the same privacy, security, or accessibility standards as ours. Please read the linked websites’ terms and conditions.

DailyFX provides forex news and technical analysis on the trends that influence the global currency markets.Learn forex trading with a free practice account and trading charts from FXCM.

DISCLOSURES

References

Forex Vs Stocks, https://www.fxcm.com/insights/forex-vs-stocks/

[1] CME Group, E-micro Euro/American Dollar Volume, http://www.cmegroup.com/trading/fx/e-micros/e-micro-euro_quotes_volume_voi.html (Accessed 9 December 2015)

[2] CME Group, E-mini Euro FX Volume, http://www.cmegroup.com/trading/fx/g10/e-mini-euro-fx_quotes_volume_voi.html (Accessed 9 December 2015)

[3] CME Group, Euro FX Volume,http://www.cmegroup.com/trading/fx/g10/euro-fx_quotes_volume_voi.html (Accessed 9 December 2015)

[4] September 2013 Triennial Central Bank Survey, http://www.bis.org/publ/rpfx13fx.pdf

[5] Bats 2016 Market Volume Summary, https://www.batstrading.com/market_summary/ (Accessed 4 May 2016)

[6] Algorithmic Trading: Winning Strategies and Their Rationale, http://www.amazon.com/Algorithmic-Trading-Winning-Strategies-Rationale/dp/1118460146/ref=asap_bc?ie=UTF8 (Accessed 4 May 2016)

[7] http://seekingalpha.com/news/3178539-strong-volume-numbers-cme-group(Accessed 4 May 2016)

https://www.dailyfx.com/conflict-disclosures

Source : DAILYFX.COM




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