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.