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Trading Viewpoints: Tick Tock, How to Trade the Clock
Our embedded traders work alongside portfolio managers and analysts to constantly assess market structures, liquidity and execution. These functions seek to help enable operational alpha by reducing risks, minimizing transaction costs and taking advantage of price differentials. To support our analysis, we gather and evaluate uniquely curated datasets. Below is the outcome of one such analysis:
Transaction costs in foreign exchange can be a significant drag on emerging markets debt portfolios if not carefully managed. As a result, foreign exchange trade execution strategy becomes a vital component of such portfolios. One key decision in minimizing transaction costs is determining the optimal time of day for execution. Unlike exchange-traded markets, the foreign exchange market operates 24 hours a day without official opening or closing times, making timing decisions dependent on the analysis of transaction costs.
There are various ways to measure transaction costs, but one of the most common methods is through bid/offer spreads. Each day, we gather over 300 million unique, executable foreign exchange bid and offer prices across various currency pairs, tenors, and sizes. Using this data set, we conducted an analysis to determine optimal trading times. We sorted six-months of data by date and hour and calculated an average bid/offer spread for each hour. These spreads reflect execution costs under typical conditions.
The results for Latin American currency pairs indicate that bid/offer spreads are substantially wider outside of local market hours. The Mexican Peso is a notable exception, maintaining consistent liquidity and spreads across London and New York trading hours, due to its status as one of the most liquid emerging market currencies. For other Latin American currencies, executing trades during local hours can drastically reduce costs. For instance, waiting until 9 AM to trade the Chilean Peso can cut transaction costs by 75% compared to trading at 7 AM when many US based investors start trading. Similarly, trading Peruvian Sol before 1 PM can reduce costs by over 50%, even though other Latin American currencies continue to trade efficiently later in the afternoon. Maintaining high-quality data and monitoring changes are crucial for capturing these nuances.
Asian currency pairs present a different picture. They exhibit relatively stable transaction costs even outside local market hours. For example, the Indian Rupee incurs similar transaction costs at 3 PM New York time as it does at 3 PM Indian Standard Time. This trend applies to most Asian emerging market currencies. Liquidity in these markets has significantly evolved, enabling efficient trading during New York hours, which was not possible in previous years. Sophisticated investors can detect these shifts through detailed data analysis.
Market structures and liquidity in emerging markets evolve, sometimes for the better and sometimes for the worse. Savvy investors must adapt their portfolios to these changes, relying on data to stay informed. In foreign exchange, data is an essential tool to track market structure evolution. For Asian currency pairs, data may confirm new developments, while for Latin American it may highlight a slower pace of change. Regardless, we believe monitoring these shifts is critical for efficient portfolio implementation.
Disclosure:
The information contained herein represents a simplified presentation of a complex process. Our investment process is subject to change and may differ materially from what is stated herein.
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