Episode 03: Institutional Forex Trading, Execution And Liquidity

As part of our View From the Desk series on B2B liquidity and related topics, this article will explore institutional forex trading, execution and liquidity. We will leverage our first hand experience as an institutional liquidity provider to offer valuable insights into forex trading.

What Is Institutional Forex Trading?

Institutional forex trading refers to professional entities, such as hedge funds, market makers, and prime brokers, managing substantial currency transactions, with daily global volumes sometimes exceeding $7 trillion. This requires significant liquidity pools, lightning-fast execution speeds, and highly competitive spreads as forex traders aim to create maximum trade efficiency, reduce price slippage, and maximise returns and profits.
Retail trading on the other hand is carried out by small traders, often through brokers, on a significantly smaller scale. Whilst they do not have access to the variety of instruments and resources that institutional traders do, they have the benefit of added flexibility and freedom within trading decisions.

The Role of Liquidity in Forex Markets

Liquidity plays a crucial role in the smooth running of foreign exchange markets and can affect them in the following ways:

• Improves trade execution: High liquidity allows for large orders with reduced price slippage, while low liquidity has the opposite effect leading to wider spreads and unfavourable execution.
• Supports market stability: Deep liquidity helps to stabilise markets with minimal price movements by absorbing large trades to help ensure steady order flows.
• Mitigates volatility: During times of market turbulence, strong liquidity can help reduce volatility by acting as a buffer against sharp price swings.
• Enables advanced strategies: Sufficient liquidity helps support more complex trading, such as hedging across several currency pairs.
• Encourages participation: A liquid market can attract more participants by offering tighter spreads, faster execution and more predictable pricing.

How Institutional Traders Access Liquidity

Institutional traders such as banks, prime brokers, or hedge funds rely on deep liquidity to help optimise trading. There are several avenues for institutions to secure access to liquidity including traditional prime broker relationships. However, many institutions turn to prime-of-prime providers like iSAM Securities¹ for more accessible and flexible solutions. Below are a few examples of access points:

• Partnering with Tier 1 LPs providing access to currency pairs and instruments.
• Using Electronic Communication Networks (ECNs) to match buy and sell orders across multiple participants, often resulting in tighter spreads.
• Using trading platforms that utilise powerful algorithms to optimise execution.
• Accessing pools outside public exchanges, better known as dark pool trading.

As a prime of prime, iSAM Securities leverages our relationship with Tier 1 banks to connect clients to robust liquidity without the high barriers to entry required to trade directly with them.

Challenges Accessing Liquidity

Accessing liquidity in large-scale forex trading can pose numerous challenges. Below are some potential difficulties that institutional traders might need to overcome:

• Global compliances related to forex trading, such as the FX Global Code of Conduct.
• High infrastructure costs associated with the technology required to trade effectively, including platforms and connectivity.
• Due to the decentralised nature of the forex market, spreads covering multiple providers can create inconsistent pricing and delays in execution.
• Market conditions such as volatility or periods of low trade.
• Balancing tight spreads and quick execution, where one may come at the cost of the other.

How Can Liquidity Providers Help?

Liquidity providers like iSAM Securities can help institutional traders with liquidity by offering:

• Multi-asset liquidity, including FX, metals and indices, enabling clients to trade at scale without compromising execution quality.
• Competitive, consistent spreads even during periods of volatility to help reduce execution costs and manage slippage.
• Liquidity sourced from relationships with Tier 1 banks.

Execution Strategies in Institutional Trading

Forex trading involves vast amounts of capital and requires precise execution strategies in order to minimise costs and slippage. Institutional traders employ several techniques to help improve performance whilst managing large volumes. Key execution strategies include:

• High-Frequency Trading (HFT): Employs systems that can leverage market opportunities in milliseconds to capture incremental gains across high trading volumes.
• Time-Weighted Average Price (TWAP): Executes trades evenly over a specific period, helping create a medium execution price, often used for large orders as it aims to reduce impact.
• Volume-Weighted Average Price (VWAP): Executes during times of liquidity peaks, reducing costs and average prices by following market volume.
• Stealth Orders: to hide intent by showing a portion of the full order.
• Smart Order Routing: finding the best venues based on price, speed and liquidity depth.

Key Players in Forex Liquidity Provision

Episode 1 of our View From the Desk series provides a quick guide to the world of institutional liquidity providers. You can read the article here, ‘Institutional Liquidity Providers Explained’.

Challenges of Liquidity and Execution

Institutional Forex traders face numerous challenges related to liquidity and execution. If left unaddressed, these challenges can negatively impact trade outcomes. These could include:

• Delays in the execution of a trade, also known as ‘execution latency’. Milliseconds can make a massive difference – read our article on the importance of speed: Latency, Liquidity, and Precision: The Real Value of Speed
• Placing large orders which could potentially move prices unfavourably, particularly during periods of illiquidity.
• Slippage, which refers to rapid price movements resulting in trades being filled at a worse price than expected.
• Geopolitical events, including trade disagreements, elections or conflict.
• The evolving regulatory and compliance environment which can introduce further complications to trading.
• Macroeconomic data releases, such as CPI or central bank decisions, which can significantly impact markets.

Impact of Technology on Trading Efficiency

Technological advancements can massively impact trading efficiency. Key benefits include faster execution speeds, reduced costs for high-volume transactions, real-time monitoring and data tools, machine learning and insights, and lowered operational costs as a result of improved efficiency.

• Best Practices for Optimising Execution
• Following established best practices can help mitigate challenges and improve performance and outcomes. Key strategies include:
• Monitor macroeconomic calendars to anticipate important announcements that may affect markets, such as; CPI release, jobs reports, GDP figures, trade balance announcements and interest rate decisions
• Diversify liquidity sources to reduce exposure and ensure access during volatile periods.
• Implement a risk management tool that monitors factors such as slippage and execution quality.
• Invest in co-location infrastructure to improve performance and reduce delays.
• Time trades to avoid low-liquidity periods

Summary

Selecting the right forex trader can significantly impact trading profitability and efficiency. If you require further information or would like to learn more about forex trading and how we can support your strategy, please contact our team.

¹ iSAM Securities (UK) Limited, iSAM Securities (HK) Limited and iSAM Securities (Global) Limited, iSAM Securities Limited and iSAM Securities (USA) Inc. are together “iSAM Securities”.