A recent academic research looks at effects of algorithmic trading during turbulent times:
Authors: Breedon, Chen, Ranaldo, Vause
Title: Judgement Day: Algorithmic Trading Around the Swiss Franc Cap Removal
A key issue raised by the rapid growth of computerised algorithmic trading is how it responds in extreme situations. Using data on foreign exchange orders and transactions that includes identification of algorithmic trading, we find that this type of trading contributed to the deterioration of market quality following the removal of the cap on the Swiss franc on 15 January 2015, which was an event that came as a complete surprise to market participants. In particular, we find that algorithmic traders withdrew liquidity and generated uninformative volatility in Swiss franc currency pairs, while human traders did the opposite. However, we find no evidence that algorithmic trading propagated these adverse effects on market quality to other currency pairs.
Notable quotations from the academic research paper:
"We analyse the role of AT in foreign exchange (FX) markets in a period containing the 15 January 2015 announcement by the Swiss National Bank that it had discontinued its policy of capping the value of the Swiss franc against the euro. This ‘Swiss franc event’ represents a natural experiment as one of the largest shocks to the FX market in recent years and probably the most significant ‘black swan’ event in the period in which AT has been a prominent force in FX markets. In particular, we study the contribution of AT and human traders to two important dimensions of market quality, namely liquidity and price efficiency. Our analysis is based on a unique dataset with a detailed identification of AT obtained from EBS Market, which is the leading platform for electronic spot FX trading in many of the major currencies.
A detailed understanding of AT in distressed situations is important for at least two reasons. First, a better comprehension of whether AT is beneficial or detrimental for market quality in extreme situations would help inform the ongoing reform of trading venues. Second, the resilience of an exchange system depends on the behaviour of different types of market participant and their reciprocal influence on each other. For instance, a tendency of AT to offer liquidity in calm markets and withdraw it in distressed situations could lead less sophisticated agents to become reliant on high levels of market liquidity only to find it in short supply when they most needed it. If these adverse consequences of AT were predominant or not offset by other traders, then AT could represent a systemic threat to the whole trading system. To shed light on this key issue for financial stability, we analyse whether human traders and AT substitute for or complement each other in supplying and consuming liquidity.
We proceed in three steps. First, we describe the EBS Market platform and our sample of data from it. Second, we perform an in-depth analysis of market liquidity and price movements by decomposing order flow, effective spreads and intraday volatility by type of trader. This enables us to highlight the contribution of AT and human traders to liquidity provision and consumption, transaction costs and realised volatility. Third, we study the contribution to efficient pricing of AT and human traders."
To learn more about this study and findings, view the full article on Quantpedia website:
Quantpedia Mission is to process financial academic research into a more user-friendly form to help anyone who seeks new quantitative trading strategy ideas. Quantpedia team consists of members with strong financial and mathematical background (former quantitative portfolio managers and founders of Quantconferences.com) combined with members with outstanding IT and technical knowledge. Learn more about Quantpedia here: https://quantpedia.com
This article is from Quantpedia and is being posted with Quantpedia’s permission. The views expressed in this article are solely those of the author and/or Quantpedia and IB is not endorsing or recommending any investment or trading discussed in the article. This material is for information only and is not and should not be construed as an offer to sell or the solicitation of an offer to buy any security. To the extent that this material discusses general market activity, industry or sector trends or other broad-based economic or political conditions, it should not be construed as research or investment advice. To the extent that it includes references to specific securities, commodities, currencies, or other instruments, those references do not constitute a recommendation by IB to buy, sell or hold such security. This material does not and is not intended to take into account the particular financial conditions, investment objectives or requirements of individual customers. Before acting on this material, you should consider whether it is suitable for your particular circumstances and, as necessary, seek professional advice.
We appreciate your feedback. If you have any questions or comments about IBKR Quant Blog please contact firstname.lastname@example.org.
The material (including articles and commentary) provided on IBKR Quant Blog is offered for informational purposes only. The posted material is NOT a recommendation by Interactive Brokers (IB) that you or your clients should contract for the services of or invest with any of the independent advisors or hedge funds or others who may post on IBKR Quant Blog or invest with any advisors or hedge funds. The advisors, hedge funds and other analysts who may post on IBKR Quant Blog are independent of IB and IB does not make any representations or warranties concerning the past or future performance of these advisors, hedge funds and others or the accuracy of the information they provide. Interactive Brokers does not conduct a "suitability review" to make sure the trading of any advisor or hedge fund or other party is suitable for you.
Securities or other financial instruments mentioned in the material posted are not suitable for all investors. The material posted does not take into account your particular investment objectives, financial situations or needs and is not intended as a recommendation to you of any particular securities, financial instruments or strategies. Before making any investment or trade, you should consider whether it is suitable for your particular circumstances and, as necessary, seek professional advice. Past performance is no guarantee of future results.
Any information provided by third parties has been obtained from sources believed to be reliable and accurate; however, IB does not warrant its accuracy and assumes no responsibility for any errors or omissions.
Any information posted by employees of IB or an affiliated company is based upon information that is believed to be reliable. However, neither IB nor its affiliates warrant its completeness, accuracy or adequacy. IB does not make any representations or warranties concerning the past or future performance of any financial instrument. By posting material on IB Quant Blog, IB is not representing that any particular financial instrument or trading strategy is appropriate for you.