Research-coming from a trading floor near you

Global Finance, Jun 2003 by Halls, Michael

Tracking the direction of money flows is becoming an important research tool.

With hundreds of billions of dollars of cross-border trades being executed every day, a new form of research has emerged-analyzing these flows and using them as a predictive tool.

At the cutting edge of this analysis have been two banks-Citibank, the largest foreign exchange trading bank in the world and State Street, one of the largest custodian banks.

The theory is simple. By analyzing trade flows-how much buying and selling of a product is going on-analysts are able to form a picture of supply and demand. That then gives an indication of where the prices should go: Is it a buy or a sell?

The flows, however, must be large to have any meaning. Citigroup, which executes between 10% to 15% of the trades in the $1 trillion a day foreign exchange market, is in an enormously strong position in currency analysis.

"So, for example, over the last month we've been able to see two sides of the picture with dollar/yen," says Philip Brass, a vice president in Citigroup's FX division. "Market opinion has been that Bank of Japan intervention might not work. However, we saw Japanese corporates withdrawing from their normal selling of USD/JPY while Japanese real money investors were happily buying the dollar-apparently in the expectation that intervention would work.

"Knowing both sides of the supply and demand picture in a highly qualitative format gives you a better angle on future price than simply watching the current noisy price action."

It's not just trading operations that generate enough activity to throw off patterns.

As a global custodian, State Street administers some $8 trillion of fund managers' money-and trades between 1 million and 10 million of securities a day on their behalf. That gives it considerable insight.

"Our analysis is different from regular research in that we're not offering straight buy or sell recommendations," says Simon Wilson-Taylor, head of Global Link, State Street's trading platform. "We're offering our understanding of what's going on in the markets. How that is interpreted into an investment strategy is the client's responsibility."

Although State Street produces written research, one of the key features of this analysis is that it is mostly seen online. Other custodian and trading hanks-Bank of New York and Bank of America-are also developing research capabilities linked to their trading flows.

One of the more unusual foreign exchange prediction research and analytics available comes from Olsen Group, a Swiss organization that has compiled almost 20 years of foreign exchange data. It has then cleaned and interpreted the data to produce a set of forecasting tools and research that it claims will invariably give an edge to FX trading. It has even produced an Internet trading platform, oanda.com, that has automated the findings.

So confident is he in its findings that on top of its trading platform, its founder Richard Olsen, an economist, has taken the unusual step of using his analytics to set up his own hedge fund.