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And Finally…

Following last month’s
appearance in this column by Run DMC, this week another surprising name pops up
– Jeremy Clarkson!

How? Well most
observers expect there to be more “flash” moves in exchange rates, which raises
the question – can (and how does) a prop trader take advantage of such price

I use the word “can” because
they seem to be getting quicker, and when the move reverses it does so at
incredibly high speed. There are people I speak to that believe we are close to
having these moves in a matter of seconds, making it incredibly difficult for
the human trader to react.

In some ways this is a
good thing – the “glass half empty” view says that there is every chance the
human will sell or buy just at the zenith of the flash move, and end up wearing
a nasty loss.

This column, as
always, prefers, however, to take the “glass half full” view – so how can a
trader take advantage?

The answer is a little
depressing for humans traders because I tend to agree that when markets go out
of kilter for no reason other than a short-term lack of liquidity the move is
likely to get quicker and only rarely will they be able (or be brave enough!)
to jump in and take advantage.

So the answer seems to
be use technology. Algorithms measure everything in markets so can they analyse
the size of a move in the market against the available information? This would
be a mix of a counter-trend strategy and a news reading algo, one in which the
algo sees the market move more than a certain distance in a certain amount of
time (a “flash” move), checks to see if a major announcement has hit newswires,
and, if nothing has been posted, counter trades the flash move.

I suspect this could
be a very risky strategy but I am sure criteria can be added to help alleviate
some of the risk involved. If people are right and we are going to see more of
these moves then an alpha generating trader (human and electronic) needs to
develop a strategy to help deal with it.

Obviously the first
issue is the checking of stop losses taken out in a flash move – should the
original position be reinstated? And if it is, can it be done quick enough to
avert taking a nasty loss for little or no reason?

But beyond that, is
there the potential for a strategy that counter trades the flash move? I think
there probably is, because in spite of the occasionally irrationality of
markets, they don’t often move multiple standard deviations (and hold the
gain/loss) for no reason.

This is, of course, a
mean-reversion strategy for the modern market so it’s a new twist on an old
theme. Just as market makers have to get used to a new market paradigm, so too
do prop traders and those firms trading FX to make money.

There may be a further
benefit of such a development, as well. If this type of strategy is developed,
and works well enough, then more will deploy it and as such we will have fewer
flash moves.

I love it when we can
solve the world’s problems, after all, to quote the aforementioned Mr Clarkson,
“how hard can it be?”  Twitter @lamboPnL

Colin Lambert

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