Artificial Intelligence Not There Yet?

The drama of Brexit with all its arcane details of UK parliamentary procedures and rarely noted characters that suddenly appear prominently on the global stage and utter market-moving words has turned into a complicated mess that is generating too many rapid-fire headlines per day, often in a whiplash manner, and news-reading currency-trading algos haven’t been programmed for this and are overwhelmed.

Bloomberg has published more than 1,000 Brexit headlines a day “on some days,” and Reuters “up to 400” Brexit headlines a day, according to a Reuters report. Other news outlets and wire services together also publish hundreds of headlines a day.

News-reading FX algos are programmed to react to all that instantly, but they don’t know what the next 10 Brexit stories over the next few moments are going to be, and that might put the trade on the wrong side of the next headline. Artificial Intelligence isn’t quite ready yet to sort all this out. Reuters describes it this way:

As a divided government battles a divided parliament over a way forward, the chorus of characters who can now influence events has grown, flummoxing news-reading algorithms, or ‘algos’, which are designed to parse phrases from recognized speakers before executing a trade. “The model signals are more quantitative driven and rely on historical data feeds,” said Neil Jones, head of hedge fund currency sales at Mizuho in London. “Brexit headlines have thrown a spanner in their works for the sheer number of characters moving the currency on a daily basis.”

How big is algo-driven FX trading? No one really knows. But last September, the Bank for International Settlements reported, based on survey data, that back in 2016 already, 70% of the orders on EBS, a primary central limit order book and a major inter-dealer platform for spot FX, had been submitted by algos.

This would be by all types of algos. Only a portion of those algos are news-reading algos. How large that portion of news-reading algos may be is also unknown. But given the mess that Brexit has turned into for news-reading algos, humans have stepped in to curtail them – given the risks involved in a big trade ending up on the wrong side of the next headline. Reuters, citing a source:

Some hedge funds have opted out of trading sterling altogether because the usual models they rely on don’t work in the current climate, according to one FX trader at a major UK investment bank. Their models are based around economic data and expectations for Bank of England rate changes, but those have become secondary drivers compared with political news, he said.

“If it was your job and given the complexity of the Brexit story, do you really want to precode something to automatically infer and put material risk on the back of that? Probably not,” David Leigh, global head of FX spot and electronic trading at Deutsche Bank, told Reuters.

So keeping those algos under control and preventing them from causing huge losses because they traded on one headline too soon, humans are stepping in. Reuters:

Some banks are ensuring that trading the pound is not left completely to the machines while other banks are using tiny orders within narrow trading ranges to prevent large losses.

Then there are the market makers that provide liquidity to the market by buying and selling currencies on their own account. They too use algos to set the price they will buy (bid) and sell (offer). But the headline-mess around Brexit also exposes them to the risk of ending of on the wrong side of the next headline. So they’re setting their algos to offer a wider spread between the bid and the offer, according to Reuters. This wider spread makes trading more expensive.

All this has consequences: Lower trading volumes as currency speculators are trying to wait out the drama rather than getting caught on the wrong side of the next headline. Citing CLS, a major settler of foreign exchange trades, Reuters reported that pound trading volume in February was down about 35% to $60 billion a day, from about $100 billion a day before June 2016, when the Brexit referendum was held.

With pound trading volume way down, and with market makers and traders leery of confused and whiplashed algos and looking over their shoulder out of fear of getting burned by the next headline, volatility has surged in largely directionless trading, even as volatility elsewhere has declined. The soothing aspect in all this is that humans have not been stupid enough for now to let this sort of AI-powered FX trading run amuck in a grand manner.

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