The Last Look…
Posted by Colin Lambert. Last updated: July 26, 2022
We can argue about pre-hedging and last look all we like, but has there ever been a more divisive subject in FX markets than stop losses?
In case anyone feels obliged to start discussing this, let me assure you, there hasn’t! I mention this, however, because I had a chat with someone last week about this very subject, but with a twist.
My conversant had, around the start of the year, switched to having their stop losses watched by the machine rather than the trading desk. They have, apparently, been placing stop losses with three or four of their LPs (always on an “only you” basis I am assured), but the results are uniform across all of them. More stops are being triggered than ever before and, more worryingly for my acquaintance, often they are being hit close to, or at the top/bottom of the day.
Some might suggest that I am a cynic, and they wouldn’t be too far from the truth in some ways, for my first suggestion was a simple observation that the firm may have been getting their trading decisions wrong and were simply having a rough period. I was assured again that this was not the case and that returns are broadly in line with expectations.
I then moved on to the suggestion that markets are busier than they have been, on a sustained basis, for several years – could this be behind it? Naturally it must play a part, but my acquaintance was adamant that, again, this wasn’t the reason.
I then broached the subject that was lurking in a dark corner of our conversation by asking if the suggestion was there was some sort of nefarious behaviour behind this trend? After all, the FX Global Code is very clear, stop losses (and option barriers) are not to be deliberately targeted.
My conversant had an interesting theory behind what was happening – in old-fashioned terms, the machine wasn’t “holding them in” the way human traders sometimes would. This could certainly be the case, although I am not sure how institutions would feel nowadays about their staff not following the letter of the agreement when it comes to stops. Certainly those traders I speak to are quick to point out they would not consider such an action – even if requested by the customer or the sales team.
On another level, this comment highlighted to me how out of touch with the modern FX world, especially the FX Global Code, some members of the buy side are. We all know that in the past certain clients were “looked after” by their sales relationship, but that was a different age – the world doesn’t work like that now, as my conversant would know if they had bothered to read the Code (which they admitted they hadn’t).
Something that is probably worth investigating at the customer, if indeed they can be bothered, is how the machine treats the stop losses when they move within the spread. Is the information used in pricing for example? If it is, then it could conceivably signal the order and increase the chances of the stop being triggered.
I came away from the conversation with the sense that what was happening was nothing to do with man or machine, in fact it was one of the oldest issues in the FX market. Too many people put their stop losses at levels dictated by technical analysis that is used across the entire market.
It is a naïve view of the world on the part of any client that believes a trader or salesperson can “keep them in”, given it is a path fraught with danger for those trying to do so
If the charts indicate an interesting level the market will often gyrate there out of curiosity. A trader may not have any orders, but if they know, for example, that 1.1950 is big support in Cable, naturally if the market gets close they will push to see what is about. They aren’t doing anything wrong, they are using public data, and, often, there are countless market participants looking at the same level and wondering the same thing.
It’s the same issue with option barriers – they can often be placed just beyond technical levels, so it is not always someone trying to knock a barrier out, it can be curiosity as to what lies beyond.
In these circumstances, I would argue that, as far as the service provider is concerned, the machine is a better place – the only place in fact – for the stop loss. There is no risk of a trader putting two and two together by looking at the charts and the orders, the machine just trades according to the rules (supposing, of course, that it does not have access to orders outside the spread).
The problem is, I would therefore argue, poor placement of orders (in market level terms not location), rather than anything untoward taking place. Effectively the client is following a well-worn path in complaining about not being held in (and probably at the level of slippage when it doesn’t work) because they think the service provider “knows” the market is going to stop there. They don’t – and even if they did, they should not act upon that information to the advantage of one client over others.
It is a naïve view of the world on the part of any client that believes a trader or salesperson can “keep them in”, given it is a path fraught with danger for those trying to do so. To me this just highlights that, for some clients, doing business the way they have for the past 20-30 years (plus) is now out of the question. If so, then at least we have anecdotal evidence that the FX market is a fairer place.
More pertinently, I would also argue that the only potential misconduct here is on the part of the client asking the trading the bend the rules by keeping them in.