The size of the global foreign exchange market (also known as forex, FX or the currency market), far exceeds any other market. It dwarfs its nearest competitor (futures market) by a ratio of about 10:1. With an estimated daily volume of more than $5 trillion, the London fixing is a big deal. Out of the $5+ trillion of daily transactions, over 50% exchanges hands through the London session, hence the “London fix” became the benchmark.
What is the London fixing?
The London fixing is the benchmark value of a currency pair on any given day from Monday to Friday. This official rate is settled at the close of the London market at 4pm local time. The majority of transactions go through the books from 3:59:30 to 4:00:30, which means, a 1-minute window of frantic activity.
The Forex market, where currencies are traded electronically and around the clock, needs to define the best time that would represent the official benchmark rate. If forex was to run its activity through stipulated times in exchanges, there would be no need for the London fix to take place.
In fact, any market that trades in an exchange such as the S&P 500 (e-mini) where we have formal opening and closing times as well as prices via the CME (Chicago Mercantile Exchange), the price settlement becomes easier to determine via the end of day instrument’s value.
With so much capital transacted, the fixing rate may not be as relevant for the average individual, but for banking institutions and asset managers that get to deal with an estimated $500 trillion worth of financial contracts, the daily reference rate at which to settle the currency rates makes a huge difference. These rates are also built into the investment mandates of many tracker funds.
Volatility at the London fixing
The reason that we tend to see above-average volatility around the London fixing is due to the aggregation of bids and offers that get cleared through major banking institutions on behalf of their clients. The majority of volume at fixings is caused by asset managers.
Because of the notion that the fixing reflects the most transparent price of the day, these entities with a fiduciary responsibility, must execute their orders around a particular time of the day to best reflect the official rate. It encourages asset managers to trade at the fix in order to match the benchmark rates used to value their holdings.
Imagine if you were a major sovereign wealth fund manager in the Middle East and you were ordered to diversify a portion worth $5 billion of the fund’s investment away from USD-denominated financial products into EUR-denominated. With so much capital at stake, you will not take any chances in transacting such a huge sum at any random time given the ceaseless fluctuations in the EUR/USD. You will demand from your broker to get the 4pm benchmark rate at the London fix instead. This will make sure that instead of being quoted a random price during the day, you will get approximately the average price between the 3:59:30 and 4:00:30.
The benchmark price is published by the WM Company since 1994. The London fix or “WM/Reuters” fix is achieved by aggregating several exchange rates including Thomson Reuters, ICAP-owned EBS and others. The rates are calculated by WM, a unit of State Street Corp.
Why it matters for retail traders
It is important to know the characteristics of the London fixing for several reasons. Since you are alerted when volatility increase happens, the usual spike in prices will not take you aback. By knowing this, you can adjust your stop loss size or profit targets accordingly. You can also set rules to stay away from a trade altogether.
There is one more aspect to consider. The London fix cut-off time is 4pm Monday to Friday, after which, the volumes and trends in the market tend to exhaust. You will notice a steady trend from around the London open that will run out of juice at the time when the overlap between the London and the New York session ends. This is due to the substantial reduction in customers’ volume orders.
There has been plenty of illegal activity around the London fix for a long time. In recent years regulators fined several bank traders for front-running clients’ orders and collusion. This activity was labeled as ‘banging the close’. It referred to using clients’ pending orders to aggressively buy or sell currencies in the 60-second fix window in order to increase the market impact for personal gains.
With this in mind, any trader should always account for markets’ volatility and its uniqueness, and treat it with equal relevance and respect.