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An Overview of Algorithmic Trading in Foreign Exchange Markets and Its Impacts on Market Liquidity

August 3, 2020
FUKUMA Noritaka, KADOGAWA Yoichi*
Financial Markets Department

  • Currently at Monetary Affairs Department

In recent years, the foreign exchange market has seen a growing presence of algorithmic trading, that is, a process of automated transactions based on pre-determined programs. Concurrently, the need to better understand its characteristics has become more important. In this paper, we construct proxy indicators of algorithmic trading in the USD/JPY spot market by focusing on its general features - high-speed and high-frequency transactions. Based on the proxy indicators, algorithmic trading has been on an upward trend since around 2016 and is more active in European and U.S. time zones than in Japan. Our analysis shows that algorithmic trading on average helps improve market liquidity in normal times. Its liquidity-providing function was generally maintained under market stress triggered by the COVID-19 pandemic from late-February to end-March 2020, though it could have been dampened albeit temporarily in times of severe stress when the market experienced sudden and sharp price fluctuation.

Notice

Bank of Japan Review is published by the Bank of Japan to explain recent economic and financial topics for a wide range of readers. This report, 2020-E-5, is a translation of the original Japanese version, 2020-J-8, published in August 2020.

If you have comments or questions, please contact Financial Markets Department (E-mail: emu-.fmd51_post@boj.or.jp).