Browse By

Improving Execution in Currencies with AbleMarkets Aggressive HFT Index: A Case Study

By Irene Aldridge

Aggressive high-frequency trading (HFT) in equities generates plenty of press.  However, aggressive high-frequency trading in currencies is also on the rise and deserves attention.  The preset case study considers the impact of aggressive HFTs on short-term price changes in GBP/USD and how execution traders can utilize aggressive HFT data to improve timing of block execution.

What is aggressive HFT? As described in detail in High-Frequency Trading: A Practical Guide to Algorithmic Strategies and Trading Systems by Aldridge (2013, 2nd edition, Wiley), aggressive HFTs capitalize on the short-term intelligence. The value of the trade quickly decreases, which is otherwise known as rapidly decaying alpha. Such intelligence may comprise advanced real-time analysis of streaming news or other information that is bound to be interpreted and traded upon by other market participants. To take full advantage of that information, aggressive HFTs place aggressive orders, preferring market orders over limit orders in a bid to ensure prompt execution. Since many aggressive HFTs move considerable volume, their dominance may last anywhere from a few minutes to half an hour. Unlike aggressive HFTs, passive HFTs predominantly place limit orders.

The bursts of aggressive HFTs’ market orders temporarily wipes out limit orders, resulting in three prominent outcomes:

  • increasing the bid-ask bounce and, subsequently, realized volatility
  • increasing slippage via increases in the bid-ask spread
  • bidding up short-term execution prices

Tracking aggressive HFT activity allows execution traders to significantly improve upon their current execution methodology. Traders charged with the acquisition of a specific currency pair over a short horizon may dramatically improve their performance by detecting an onset of aggressive HFT buying activity, usually leading to price increases, and speeding up execution in the short-term. Similarly, execution traders commissioned to sell blocks of a given currency will find improvements in execution from executing larger slices of blocks at the first sign of a rise of aggressive HFT sellers.

Figures 1 and 2 show the aggregate performance of a vanilla GBP/USD execution strategy enhanced with information about aggressive HFT activity delivered in real time by AbleMarkets aggressive HFT index (hftindex.com). The vanilla strategy executes the same size once every minute. The enhanced strategy tracks a 20-minute moving average of the difference between the aggressive HFT buyers and aggressive HFT sellers. When the 20-minute moving average of the HFT buying activity exceeds HFT selling activity by at least 10%, the buying strategy buys three-minutes’ worth of the currency volume, and executes nothing in the following two minutes. From November 18, 2015, through November 27 alone, the enhanced strategy was triggered 256 times, on average buying at an 0.3 pips lower than the benchmark (mid or ask) each time over the 8-day period. The corresponding sell strategy performed even better, on average selling at 0.53 pips above the benchmark each trading period out of 294 instances during the 8 days. Figures 1 and 2 show the aggregate price differential received from the HFT-enhanced strategy over the period for the buying and selling execution, respectively. As shown in the Figures, buying with the enhanced strategy reduced purchasing cost by nearly 80 pips over 8 days, and selling with the enhanced strategy delivered prices nearly 175 pips higher than benchmark execution.

 

Figure 1. Price differential achieved when buying using the aggressive HFT-enhanced strategy vis-à-vis vanilla benchmark strategy. When buying, the enhanced strategy, on average, obtains the price 0.3 pips lower than the benchmark.

Figure 1. Price differential achieved when buying using the aggressive HFT-enhanced strategy vis-à-vis vanilla benchmark strategy. When buying, the enhanced strategy, on average, obtains the price 0.3 pips lower than the benchmark.

Figure 2. Price differential achieved when selling with the aggressive HFT-enhanced strategy vis-à-vis vanilla benchmark strategy. When selling, the enhanced strategy, on average, obtains the price 0.53 pips lower than the benchmark.

Figure 2. Price differential achieved when selling with the aggressive HFT-enhanced strategy vis-à-vis vanilla benchmark strategy. When selling, the enhanced strategy, on average, obtains the price 0.53 pips lower than the benchmark.

The results shown in Figures 1 and 2 hold up for various currencies and extended time periods, making the aggressive HFT an indispensable item in an execution trader’s tool bag. Due to its nature, the aggressive HFT can be used to enhance both the low-touch and the high-touch execution, delivering value to execution traders’ clients and much-deserved profitability to execution traders themselves.