This column may come across as irritable, confused or just an incoherent babble – but all I can say is that the nation you love only wins the world championship in a sport you love for the first time once, but unfortunately I had to sit up until 5am to actually see it (and actually missed the critical moment because someone called me and knocked the stream out). So putting aside its impact on my ability to string a sentence together, let’s talk about reaction to last week’s columns on risk…
I ought to start by stressing (yet again) to as many people as who will listen – FX is not equities. It should never be viewed in the same light as equities because the two markets have two radically different raisons d’être – one is there to help firms raise money and offer an alternative to depositing the money in a bank, an investment vehicle; the other is at heart there to help oil the wheels of the global economy by allowing those same firms and investors to look beyond their national borders.
Amongst the feedback from last week one story stood out, and it was in response to my comments about the importance of risk takers in the market.
Towards the end of last week I heard from an old friend, still in the trading business, who told me that one of the institution’s traders had, several months ago, had “an interesting hour” with compliance because they took a position that went against the “house view”. I have to stress the upshot was no action taken, it was (finally) explained to the interviewer that temporal factors have to be taken into account and also that the house view is subject to change, often at a moment’s notice, but what an insight this provides into the paranoia that has gripped bank trading desks, or rather the compliance function.
To take this to its extreme, if a trader can only position with the house view, what is the point in having that trader sit there at all? They’re not making decisions, apparently they are being taken by one or more strategists – and rarely are these people profit centres. It’s just a great example of how stuffed up some institutions are as they continue to struggle with the aftermath of the conduct issues.
The upside is, however, that this story is a timely reminder that everything a trader does is going to be checked and double-checked and also that the default position of some people in compliance is that something is wrong until proven otherwise. That means anyone thinking of doing something remotely shady will be fully cognisant that their actions are likely to be uncovered – that is, or should be a real deterrent, but what an environment in which to operate!
Another piece of feedback that I found interesting was how many people believe that holding a position for anything up to a minute constitutes the taking of risk. Technically speaking it does, of course, and as someone who has fully embraced the e-FX era I understand how the change in market structure has driven risk holding times down, but I would still question whether such an approach is risk absorption, which is really what I was talking about last week. Holding a position for a minute may seem like a lifetime when 500 trades are executed in that minute, but is it really?
With (semi-sincere) apologies I would point out that 20 years or more ago that strategy would have been called jobbing, not trading. Yes, the market has moved on, but that should not mean that there is no room for someone to take a world view and trade it accordingly with a longer time horizon. I also believe – and this is where I dig myself in even deeper after last week’s columns, that traders should be able to use customer business to enter into these positions. It’s just another form of internalisation after all. Some institutions will require them to post a bid or offer to the e-book so that it is hit, others may be able to take the risk off the e-book at a time of their choosing – it doesn’t matter how it is done and people should not get antsy about it…unless of course they look to take profit in the first 60 seconds or so. Which is my point; the time horizon of the trade changes how we view the position entry – in one case there is clearly an attempt to make money out of a customer trade in the short term – what I would call the broking model to hark back to last week’s columns; the second is merely using flow to express a longer term view. There is no intent to make money out of the customer trade unless that world view is right.
We are probably well short of being comfortable with machines making these decisions, but obviously firms are investing in technology because it is efficient. That it is; however when volumes and short term volatility dry up as markets become more efficient themselves, is this model sufficiently profitable? The answer has to be that blend of human and machine, perhaps that is another area where the pendulum has shifted too far and is in need of a correction?
As far as I understand it, in equities markets institutions do have a house view, and their salespeople as well as their traders (if they exist) are expected to adhere to it. That is what a brokerage shop does, it seeks to promote business through ideas and revenues equate directly to customer volume. FX has gone too far that way in recent years in my opinion and needs to get back to focusing on what it does best, providing opportunities for traders of all styles to trust their judgement.
This does not mean getting rid of short term traders, it means actually having the intelligence and flexibility to understand that one view does not always represent the best approach across a broad institution – and also, crucially, that sometime things will go wrong. No-one likes to make a loss, but while that is bad news for a broking business, it should not be anathema to a trading business.