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Trading News

Battling HFT in the forex markets

I just had something come across my desk that is really interesting and ties in with the stuff in the book Broken Markets which I posted a review for the other day. One of the issues brought up by the authors of that book is the impact of decimalization on the stock market since its introduction and how we’re now seeing sub-decimalization being used by high frequency trading (HFT) systems to scalp. One of the big inter-bank dealing platforms is being pressured by its customers to fight back against a similar thing happening in forex.

EBS is also looking at addressing so-called quote stuffing, which involves putting in orders and pulling them out quickly in an effort to sense market liquidity, etc.

The pippette change is something which could have an impact on pricing in the retail forex market. The quote stuffing thing may as well, but in a less direct fashion most likely.

Here’s the full story from the Dow Jones wire.

UPDATE: EBS To Change Way It Quotes Currencies on Trading System – Sources
06/26/12 09:36
Electronic inter-dealer currencies-trading platform EBS plans to scrap the fifth decimal place on its currency quotes and introduce so-called half-pip pricing ahead of major changes to the system, people familiar with the matter told Dow Jones Newswires Tuesday.

EBS, owned by ICAP PLC (IAP.LN), has been considering a range of options that will change the way investors are allowed to trade on the system in a bid to repair relations with its core banking customer base. EBS shares a dominant position in currency markets with Thomson Reuters (TRI), but it has come under fire from its core bank clients for allowing trading behavior that seemingly favors so-called high-frequency traders in recent years. Now it is seeking to redress that balance.

“We have been engaged in a wide-ranging dialog with key customers and other market participants, reviewing all aspects of the EBS system. This includes a review of the EBS dealing rules. The review is still ongoing and we expect to complete it and share the agreed proposal during the summer,” a spokesman for EBS said in an emailed statement.

In late 2010, EBS added a fifth decimal place to its prices, allowing trades at $1.23456, for example, rather than the old-fashioned $1.2345. That last number will now be available only in increments of five, removing most of the finer price points that work best for high-speed computer-based traders.
The move is designed to increase liquidity at the available price points and takes away some ability for high-speed traders to anticipate where the market will move next, one person familiar with the matter said.

“It’s a massive turnaround,” this person said.

Other changes being considered include so-called fill ratios, which would require a certain percentage of orders sent to the platform to be traded, addressing bank traders’ concerns that many high-speed trade requests are speculative steps to judge where the market might move next, rather than genuine requests to trade. Minimum trading sizes and cancellation times are also under review, according to people familiar with the firm’s plans.
The rethink in strategy comes after the shift to decimal pricing in late 2010 caused relations between EBS and traditional customers to sour. Although most electronic trading platforms currently quote foreign exchange prices up to a fifth decimal place, banks felt the move on EBS favored high-speed funds too much.

Earlier this year EBS announced a raft of senior management changes that saw Gil Mandelzis replacing David Rutter at the helm of the trading system. Since the appointment of Mandelzis, EBS said it would review its trading rules to “eliminate certain types of behaviors” from the system. Mandelzis added that EBS isn’t seeking to become a bank-only platform.

The changes in strategy come after some of the biggest currency-trading banks announced the formation of traFXpure, a rival trading system that is set to launch toward the end of this year. The project was announced after more than 18 months of planning and includes Deutsche Bank (DB), the world’s biggest foreign-exchange trading bank by volume.

Write to Eva Szalay at eva.szalay@dowjones.com

(END) Dow Jones Newswires
June 26, 2012 09:36 ET (13:36 GMT)
Copyright (c) 2012 Dow Jones & Company, Inc.

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Reader Questions Answered

Working Out Position Size in Forex Trading

I got this (slightly edited) private message inquiry from a Trade2Win member yesterday. It gives me a chance to reiterate something which has new forex traders minds spinning regularly for nothing.

… wondered if you could assist me in working out my position sizing for different currency pairs? Be great if you could as im a bit stumped…

Say i have an account of £10,000

I want to risk 1% which = £100

I’d like to buy usd/chf @ 10500, with a stop of 20 pips @ 10480.

How do i go about working this out if i have leverage of 100:1?

Dealing with USD/CHF pip values isn’t quite as clean and easy as dealing with those of EUR/USD where they are fixed (in dollar terms), but it certainly can be done. The math isn’t all that hard.

To get the pip value for a pair where the USD is the base currency (quoted first) you are effictively determining what a pip represents in % terms relative to the market price. In this case we’re looking at USD/CHF with a starting value of 1.05, thus

Pip % value = .0001/1.05 = 0.00952%

So if we’re trading a full standard lot ($100,000) then the pip value will be $9.52, which is $100,000 x 0.0000952.

Now the question is how to determine position size based on a 20 pip stop loss for a given risk exposure. The first step there is to figure out the 20 pip % value. That’s 0.0020/1.05, or 0.19048%. From there you have to do some algebra to figure out the size of the position based on how much you are risking. You’re using this base formula.

R = PPV x S

Where R is risk amount in $, PPV is the pip % value for the number of pips you’re risking, and S is the position size in $. Flipping that around to solve for S you get:

S = R/PPV

Using our example, we have a £100 risk. If the GBP/USD exchange rate is 1.50, that’s a $150 value for R. Plugging in that into the formula above and we get:

S = $150/0.19048 = $78,750

Rounding down that gives us either 78 micro lots or 7 mini lots.

We can put all of the above into one formula.

S = R/(Pf/Pr)

Where Pf is the pip fraction (decimal difference between entry and exit) and Pr is the current market rate for the pair in question. Using our example numbers we have:

S = £100/(.0020/1.0500)

Using the GBP/USD value of 1.5 that becomes

S = $150/(.0020/1.0500) = $78,750

Now here’s where the 100: 1 leverage question comes in. Ready? It’s very simple. You just have to ask this question:

Based on my permissible leverage, can I take a position this size?

In this example where a £10,000 account is being used, so long as a major chunk of those funds aren’t already being used for margin on other positions, the answer is yes.

To put it another way, the leverage question plays absolutely no part in determining the size of the position you take when you are working out that size from how much risk you want to take other than to set the upper end limit of how big that could be.