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If one were to express a view in Sterling at 10am against the US Dollar, or Japanese Yen, that position would be far less likely to be affected by news in the other currency, than trading against the Euro or Swiss Franc, which may have their own news, or economic data, released during that time, affecting the position.

Similarly, taking a view on the Pound at 3am against the Japanese Yen is more likely to be affected by news or economic data in Japan at that time of day and has more of a Yen exposure.

Therefore, any trading system must also take into account the time it is being executed for each currency pair.

Figure 1 illustrates the native trading hours for each currency expressed in GMT.

Liquidity

Some pairs are more actively traded than others and this has a direct relation not only to their spreads, but also their behaviour.  Although each pair may have the highest volume during the London afternoon, as we saw in the last article, some currency pairs are still far more liquid than others, throughout the day.

Figure 2 lists the currency pairs in approximate order of liquidity, with EURUSD, USDJPY and GBPUSD accounting for 52% of all FX volume (source: Bank of International Settlements, Triennial Central Bank Survey of Foreign Exchange and Derivatives Market Activity, April 2007).

This makes the spreads, and therefore slippage and cost of execution, much smaller in the more liquid currency pairs.  Therefore a strategy that is equally profitable in EURUSD and AUDCAD without slippage will not be nearly as profitable in AUDCAD in live trading, when spreads and slippage are factored in, due to the much wider spreads and relative lack of liquidity in AUDCAD.

It’s also usually better to trade an illiquid cross via its components. For example, selling AUDUSD and selling USDCAD results in a net short AUDCAD position.  Trading via the components in this way usually captures a better spread than the trade being done ‘direct’ in relatively illiquid crosses. 

 

 

Turnover in Billions (USD)

% Share

EURUSD

 840

27

USDJPY

 397

13

GBPUSD

 397

12

AUDUSD

 175

6

USDCHF

 143

5

USDCAD

 115

4

USDSEK

 56

2

USD/Other

 572

19

EURJPY

 70

2

EURGBP

 64

2

EURCHF

 54

2

EUR/Other

 112

4

Other Pairs

 122

4

Total

 3 081

100

Source, BIS Triennial Survey 2007

Figure 2

Unfortunately that also doubles the brokerage costs per million, versus being able to execute the trade ‘direct’ in AUDCAD, as two trades are done instead of one.  This effect is even more pronounced if the strategy was executed during relatively illiquid times of day.

Further exacerbating the situation is the fact that stop loss orders can only be left ‘direct’, without the use of an API, usually resulting in much more slippage when orders are executed in the market.

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