Peter from Ireland wrote in asking me to do a piece on liquidity on
the forex market. Although the market trades 5 trillion dollars per day
in volume, even forex traders face limitations in how much volume they
can push through in a short period of time.
A Zero Hedge article on the Reuters 3000 platform outage
cited some interesting statistics for the currency markets and where
the trading actually occurs. Although I was familiar with Reuters and
EBS previously, the Dow Jones article was the first place where I've
seen volume statistics published. Apparently Reuters, the biggest
platform, trades approximately $130 billion dollars in volume per day.
That's an astronomical amount of money. Intuition makes it feel like hitting
the ceiling on executing large transactions might be a problem for only
the biggest institutions. Let's take a look at where we might expect to
run into problems.
When I went through broker training at FXCM,
the team leader cited the EUR and USD as being involved with 60% of all
forex trading volume. That number does not imply how much volume occurs
in the specific EURUSD pair. Also, that that was seven years ago. I dug
around looking for more up to date numbers. Forex trading volume is
notoriously hard to track due to it being an over the counter market.
The best proxy that I know of is the FX futures market.
The CME publishes FX futures contracts volume
(page 16), which I used to estimate the proportion of the EURUSD pair
in relation to all traded volume. FX futures contracts, like their spot
counterparts, are all denominated in different currencies. Except for
the e-mini and e-micro contracts, which resemble the mini lots of retail
forex trading, the contract size is roughly $150,000. I'm counting
contracts rather than actual notional value to speed up the
calculations. You can double check my calculations by downloading this spreadsheet. The EURUSD pair represents 33% of all forex trading volume based on my rough estimates.
The
EURUSD value traded per day on Reuters is 33% of $130 billion, which is
43.33 billion. The average trading consists of 1,440 minutes per day.
43.33 billion trades per day / 1,440 minutes per day yields an average
traded amount of $30,092,592 traded per minute. Again, this is a huge
number.
Everyone in forex trades on margin. Institutions
traditionally keep their margin very low. Assume that 3:1 is the norm
for the big players. That means that the actual funding in the account
only needs to be $10 million dollars (30/3). That's a lot of money, but
that is chump change by institutional standards. That's more on par with
a wet behind the ears CTA that launched within the past few years. This
scenario is for the most liquid currency pair on the largest currency
trading platform in the world.
Dropping down to the retail scenario, the numbers involved get much, much smaller. The Financial Times cites FXCM's average trading volume
as $55 billion per day. This is tens of multiples higher than an
average broker's volume. I picked it because it's the highest that I
know of and I wanted to demonstrate a big scenario. 33% of $55 billion
is $18.15 billion traded on the EURUSD. $18.15 billion / 1,440 minutes
per day is $12.6 million traded per minute.
Retail traders
leverage far higher than institutions. Again, let's be kind and make the
assumption that the average retail trader employes 15:1 leverage on the
account (hint: it's much higher). $12.6 million / 15 implies that it
only takes an account balance of $840,277 to trade all of the expected
trading volume in an average minute. One trader is unlikely to have a
balance that large, but a segment of a broker's customers most certainly
do.
The fragmentation of the market combined with leverage makes
it strikingly easy for a group of traders to suck up all of the
liquidity available on a given platform. Even though trillions are
available across the broader market, the broker or platform where a
trader participates is substantially more limited. The scenarios modeled
use the EURUSD, the most liquid pair in the world. Liquidity gets
exponentially worse when examining exotics or cross currencies. The
volumes are far lower, but the available leverage and account balances
remain the same.
When too many traders buy the same EA, all orders
fire off at the same time. Blockbuster EAs easily reach the combined
account equity floor where demand overwhelms supply. Finer details like
all of the supply is being one sided make the situation all the worse.
