Please note that as this coming Friday (Good
Friday, 18th April) is
a holiday for all important Forex markets, there will be no OmiCronFX
commentary on that day.
Since the publication of Michael
Lewis’s new book “Flash Boys”, there has been much discussion of the way in
which larger hedge funds and other traders utilise various methods of gaining
an advantage over the great majority of traders, not only in Forex but wherever
electronic trading takes place, whether that is in equities, indexes or any
other asset class.
It turns out, however, that
the regulatory authorities around the world had been examining these practices
already. In Europe , in particular, there have
been proposals, for some time, to curb activities that might be perceived to be
anti-competitive. The most basic was the idea that a half-second delay might be
imposed on the sending of a trade by a trader to an exchange. This would take
care of, with one stroke, the activities of High Frequency Traders (HFTs), who
utilise very high speed computer (low-latency) connections that allow them to
capture trades as they are being transmitted by others to the brokerage
servers, add on a tiny amount to the price for themselves, and then allow the
trade to go through. This is known as “front running”. It is manifestly unfair.
But there are other ways in
which advantage can be taken – other methods of front-running. One of these is
the ability of well funded traders to purchase the outcome of reports that can
be expected to move the markets, before these results are known to the bulk of
participants. It is not suggested that this can happen in the case of, say, the
US Non-Farm Payroll reports, as these are released by the government, but there
are others where the playing field is not so level. One is the University of Michigan Consumer Sentiment Index , which
is released in conjunction with Reuters.
The debate is on as to
whether it is anti-competitive, on the one hand, to allow this, or a legitimate
exercise in market analysis, for which the analysts deserve to be paid, on the
other. Our own view is that the question, at this level at least, is not that
important. The reason for this is that, very often, it would appear that when
they get them, the recipients of these reports do not know what to do with
them. There is often no consensus as the whether it is better to buy or to sell
when the results are known. The chart above illustrates what happened in the
minutes before, during and after the Univ.
of Michigan / Reuters
Consumer Sentiment Index release for January of this year.
Something similar happened on
Tuesday of this week, when UK
inflation figures were released. The consensus expectation was for a year-on-year
drop to 1.6% from 1.7%. When this proved to be absolutely correct, the value of
Sterling
initially dropped, presumably on the belief that this is a low level for
inflation. A few minutes later it reversed totally, when other traders seemed
to come to the conclusion that, hey, this was as expected - at least the figure
did not come in lower than that.
The point here is that any
traders who had received this information ahead of time and had reacted as the
first lot did when we were watching the chart, would have been burned. That is,
unless the move down was an attempt to hunt for stops in the sure knowledge
that the rate was about to rise thereafter. OK, call us cynical – and our stops
were not triggered.
The Tobin Tax
Back in 1972 the economist
James Tobin who, sadly, is no longer with us (he died in 2002) proposed that
there should be a very small tax on currency exchange transactions in order to
“cushion exchange rate fluctuations”. In his view this would limit the amount
of volatility that takes place and which sometimes give rises to distortions,
of exactly the kind that High Frequency Traders are sometimes accused of
causing.
While the idea of a Tobin Tax
is under active consideration in the Eurozone, it is opposed strongly by the USA . Britain and Ireland
have made it known that they will veto the introduction of such a tax in
Europe, as to allow it would mean the abandonment of London , in particular, by currency traders
who would have no difficulty in today’s world of easy international
communications in moving their operations elsewhere.
We sometimes wonder if it
would not be better to allow a Tobin Tax, of a very small size, in return for
the regulators making sure that High Frequency Traders cannot skim similar
amounts off the value of trades that go through electronic exchanges but in
what, up to now, has been a hidden and opaque manner. At least a Tobin Tax
would have the virtue of being transparent.
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