Aligning QEA Drivers in the Pursuit of Alpha

Last week, Forex Datasource published a blog entry and a report following a quantitative study of CLS intraday activity. Our focus was to measure the degree to which average trade size and intraday volatility vary by 18 currency pairs and by time of day. As a follow up, we asked seasoned and respected market practitioner Howard Tai to give us his take, what part of our study could be most useful to institutional traders.

Not only did we get examples that show practical applications of our findings, but also put the importance of average trade size in context and delved in a discussion of quality execution analysis (QEA) that is engaging.

What follows are some excerpts of Howard’s report on QEA drivers in the pursuit of alpha generation.

“The rise in eFX trading activity and in adoption of pre-trade and real-time analytic tools has placed increasing importance in what is now termed “quality execution analysis”. QEA is focused on analyzing pre-trade liquidity, at-trade market impact, and on-the-fly strategy change implications of FX orders executed via exchange-like market environments known as central limit order book (CLOB). In this author’s view, QEA is a subset of FX TCA and a key component in measuring FX best execution.

The buy-side is moving away from analyzing trades merely on a post-mortem basis and toward actively managing trades to generate short-term alpha. As FX TCA sophistication has grown, so has the appetite of institutional traders for intraday and even real-time analysis. This is occurring because more buy-side firms are trying to actively incorporate QEA data into their trading processes.

There are, however, at least a dozen factors (Chart 1) that every buy-side manager must first consider before selecting an eFX venue or deciding on the methodology of how to carry out particular FX trades. Not all eFX venues are created equal, and the same is true of liquidity providers, as well as the depth of orderbook for certain currencies at any given time of the day.

Chart 1. Pre-Trade QEA Factors for Buy-Side Traders to Evaluate

Source: Forex Datasource, Frontline Global Markets, LLC

Given that technology, market conditions, and the availability of data are changing on an ongoing basis, an institutional client’s FX best execution policies should be a living document that embodies the principles that will aim to achieve the best transactional outcomes on a consistent basis. Such policy should also undergo at least an annual evaluation/review to maintain fresh and relevant to portfolio manager needs.”

To access a copy of this highly recommended report, please click here.