While the deep liquidity of forex allows CTAs to trade numerous strategies and time frames, it also allows them to take on additional assets without altering their approach. Scalability is one of the most important attributes of forex markets for Trimmer. "It is very deep. [If] you find a program that works, you can put a lot of money behind it before it runs into capacity issues," Trimmer says.
A manager could be the best pork belly trader around but once he gets to $15 or $20 million under management, he will not be able to grow because the strategy becomes too big for the market. This is a problem for many managers trading physical commodities — sometimes an approach works on other markets and sometimes it doesn’t but by building a strategy that trades the forex markets you are usually giving yourself room to grow.
FX Concepts, for example, grew to roughly a billion under management before expanding to carry and option writing strategies.
While forex allows a manager to grow, it also offers benefits to emerging managers struggling to gain assets. The spot forex markets allow managers to purchase a specific amount of a currency so they can offer lower minimum investments because not every customer has to be allocated a currency futures contract. This can be accomplished by offering a fund, but many investors like the safety and security of managed accounts, especially when dealing with emerging managers.
"In OTC forex you can trade any amount and get it evenly distributed among all clients," Charles says. "It is an advantage whether you are a small CTA or large CTA. You can size your trades exactly to how much risk you want to take. You can’t always size your trades exactly when you are trading futures because futures have a predetermined contract size."
Valhalla Capital Group executes a high frequency trading program that trades more than 70 currency pairs. "We have all these price feeds from ECNs [electronic communications networks] aggregated into our API. It is a culmination of strategies," co-founder Charles Campbell says.
"If we are long the euro we may use the cross between two other pairs to exit that trade. We would use the euro/pound and pound/dollar," Campbell says. "It is a little bit different than a traditional technical model. Very short term, most of the trades span a couple of minutes so there is minimal exposure."
Forex trading platforms send them their order flow and they work as quasi market makers though they have no obligation. "I can see the banks pricing and route my orders directly to the banks. If I can see through Currenex that JP Morgan is quoting me this price and I like it, I can route that order directly to JP Morgan," Campbell says.
Their models are based on price action. "We look at historical patterns on a very short-term basis. We are able to predict in the next couple of minutes where the markets are going to go and at that point it is about getting good entries and good executions on the exits," Campbell says.
It is complex and it all happens within milliseconds. Valhalla’s strategy is more akin to the type of trading occurring on proprietary trading desks of banks, but because they are operating as a CTA, the strategy is not as scalable. "If you are on a bank desk it is a different ball game. You have access to so much more liquidity than a CTA is going to have access to," Campbell says.
While most currency-based CTAs trade on technicals as opposed to fundamentals (see "The best sector," below) the universe of fundamental factors in currency markets is larger than most sectors. Interest rates are perhaps the most obvious fundamental but all economic factors that impact a country need to be watched. There is money supply, interest rates, purchasing power parity and politics. Central banks often are a large player in a nation’s currency. They, of course, are not attempting to make a profitable trade but affect the value of the currency for other purposes such as protecting their manufacturing sector against rising currency value that makes their products less competitive in the world.
Forex expert Osman Ghandour, who managed forex for sovereign governments and operated his own CTA, noted that this creates inefficient liquidity that can be exploited. Others acknowledge the effect of central banks on forex trading but believe it makes their lives more difficult.
"There is an inordinate amount of government intervention in the markets and that has made markets far more random because governments do not have a profit or loss incentive," Charles says. "We don’t know what their true incentives are and they create dislocations. Now maybe those dislocations create an exploitable opportunity." However, Charles thinks those interventions hurt more than help. "The participation of central banks in markets to the extent that they are today dulls the exploitable edges of traders on a regular basis."
Taylor agrees, noting their fundamental overlays underperform their mainly technical approach due to the vast array of fundamental inputs. "We happen to think it is too confusing. There are so many things that countries do to screw them around."
Forex markets have long been a benchmark for diversified trend following programs but the unique attributes of forex and its relationship to interest rates, along with its 24-hour liquidity, make it an ideal sector for stand alone programs. It is unlikely technical systems will pile up in the same location given the different ways to trade it and its fundamentals are dynamic, providing both challenges and opportunities for those trading it from that perspective.