Exploring Volatility and Risk Management in the Financial Markets

The Idea Hub, a platform for discussion within iFX EXPO Asia, held a panel on "Volatility and Risk Management." The panel featured industry experts sharing their insights on the current market conditions, the unexpected disappearance of volatility despite geopolitical tensions, and strategies for managing challenging flow in the financial markets.

The panel was moderated by Elina Pedersen, CRO at Your Bourse, and included industry leaders speakers: Robert Brown, Head of Strategic Development at BIDX Markets, Olivia Mottershead, Institutional Sales at Scope Prime, and Gerard Melia, Head of Sales at StoneX Pro.

Unexpected Market Volatility

Despite initial expectations of increased volatility due to geopolitical uncertainties, such as the situation in Ukraine, inflation concerns, and global economic conditions, the financial markets have remained relatively flat. Gerard Melia admitted that the disappearance of volatility halfway through the year's first half was unexpected. He suggested that the availability of cash and the impact of inflation may have contributed to the decline in trading volume. However, Melia noted that volatility has started to make a comeback in recent months, with trading volumes returning to earlier levels.

Assessing Volatility's Potential Return

Olivia Mottershead agreed that the markets have been less volatile than anticipated. She pointed out that while the Dow has remained relatively flat, the S&P has seen a 14% increase. 

Mottershead attributed the lack of volatility to conflicting factors such as the global focus on inflation and interest rates, uncertainty surrounding central bank decisions, and geopolitical tensions. Despite these challenges, she expressed optimism that a broader alignment would eventually occur when global interest rates stabilise, and countries establish their preferred paths.

Adapting to Changing Market Conditions

Robert Brown shared his perspective on how market participants, specifically brokers, have adapted to changing market conditions. He highlighted the importance of open communication between liquidity providers and clients. Brown emphasized the need for honesty, transparency, and understanding of each other's needs, risk appetite and flow. He also mentioned the role of sophisticated trading strategies and the importance of educating clients on the costs associated with such strategies to ensure a fair and mutually beneficial relationship. 

Gerard Melia pointed out that sometimes it's impossible to offset the risk in the market, as retail brokers offer much lower spreads than the real market, which leaves Institutional brokers with no possibility to offset the risk.

Managing Challenging Flow

The panel discussion delved into the concept of challenging and toxic flow in the financial markets. Elina Pedersen highlighted the importance of risk management and understanding clients' trading behavior. She raised the question of how liquidity providers should handle the toxic flow. Robert Brown underlined the significance of open communication between liquidity providers and clients. He mentioned the evaluation of trade decay and the distinction between sophisticated trading strategies and strategies that exploit the market unfairly. Brown pointed out the necessity to tailor liquidity providing to specific client needs to benefit both parties. 

When the LP knows what is coming their way, they can adjust their risk management accordingly and ensure that the flow can be digested.

Olivia Mottershead expanded on the importance of communication in the liquidity providing process. She underlined that it is essential to ensure that liquidity providers and clients are aligned regarding risk want and trading preferences. Mottershead spotlighted the value of long-term relationships and the necessity of servicing clients' needs to build trust and increase volumes. 

Gerard Melia shared his experience in managing risk as both a market maker and an institutional liquidity provider. Melia emphasized banks' stringent risk management practices, the importance of profitability for liquidity providers, and the requirement for education within the industry to understand how liquidity flows through different tiers and the value is extracted along  the way. 

Elina Pedersen also pointed out that the problem is that the institutional liquidity providers Tier 1/Tier 2, who are ultimately working directly with the banks, can not pass on the toxic flow to the banks. Meanwhile, by the time the flow reaches Tier 1/Tier 2 providers, there is no value in the flow. Hence, if the trend continues, we might end up in a situation where forming a business relationship between the Tier 1/Tier 2s is no longer beneficial for the Tier 1/Tier 2 providers. This will leave the brokers lower down the value chain in a situation where they would have no venue to offset the risk.

Conclusions

During the panel discussion on volatility and risk management, valuable insights were shared regarding the surprising lack of market volatility, even in the face of challenging global conditions. The panelists stressed the crucial role of open communication, comprehending client requirements, and customizing liquidity to strengthen mutually advantageous partnerships. They underscored the importance of proactive risk management, client education, and the ability to adapt to evolving market dynamics. As the financial markets continue to transform, market participants must prioritize effective risk management and strategic adaptation to navigate the intricate realm of volatility and optimize their trading results.