That trading in foreign exchange is not only something for professionals or people with bulging wallets is shown by the Oanda firm in Toronto. Since 2001 it has offered an online platform which allows anyone to trade in foreign currency – even if they only risk small sums. This has been made possible by the Internet and Olsen's pioneer work. The Zurich firm, founded in 1985, is the leader in developing electronic financial market products and provided the basis for Oanda's platform by studying and providing high-frequency data. This DVD gives an entertaining insight into the creative world of both firms.
- The information revolution
Great upheavals in the history of mankind were frequently brought about not by wars or natural catastrophes, but by new inventions in the field of information. The introduction of money or the invention of the printing press brought about real revolutions, the effects of which can still be felt to this day. Their significance, however, was not recognised until many years later.
Around 560 BC the first gold and silver coins were minted by Croesus, king of the Lydian empire in Asia Minor. This monetary system represented a value standard by which a great variety of goods and services could be compared and valued. Thus bartering was no longer confined to a restricted area. Artisans and merchants could expand the scope of their activities.
European civilisation has its roots in Croesus' monetary system – a system in which the origin of the individual became unimportant and whose established place in the social field was on the wane – in Asia, for example, both played a central part much longer than in our regions. Globalisation, too, as we are experiencing it today, would be quite unimaginable without a standardised and stable monetary system.
The impact of the invention of the printing press by Johannes Gutenberg around the middle of the 15th century was no less significant. The fact that more and more strata of the population were given access to information and education brought about a revolution in society. Without the art of book printing, the rapid spread of Martin Luther's theses, for example, and thus of the Reformation would not have been possible. But the democratic state systems as well, such as we are familiar with today, are based on the comprehensive information of all citizens.
A third information revolution, the consequences of which are today probably impossible to foresee, began around 1990 with the invention of the World Wide Web and web browser technology. Access to information of every kind has changed our everyday life. If we intend to buy something, we compare the prices of the different offers in the internet and place our order online; if we are planning a journey we search in the internet for the appropriate train connections; if we require information on a certain subject we go to the search engine Google; if we have to pay bills we do so by e-banking. Traders and middlemen are becoming increasingly superfluous. Changing money, trading currency, buying or selling equities is also possible for everyone today who has access to a PC with an internet connection, without having to make a detour to the bank. While the individual investor used to leave it largely to his bank and trusted its knowledge and experience, today he informs himself and carries out his transactions as if he were personally sitting in the trading room.
One of the first to recognise the chances of this latest information revolution is a small firm in Toronto, Canada, called Oanda. Millions of people are already using Oanda's currency conversion service for calculating amounts of any currency at current rates into another without using a pocket calculator.
Since 2001, Oanda has been offering an internet currency trading platform which allows everyone to participate directly in currency trading – and that at conditions which in the traditional banking business are only granted to big customers. It makes no difference whether someone wants to trade with 10 dollars or 10 million dollars.
It is the declared aim of Oanda to offer currency transactions at the lowest possible cost. The company only earns on the rate differences; no fees are charged. That is only possible because computer specialists and financial experts have succeeded in automating the entire sequence of operations.
Oanda with its currency platform is in many respects a pioneer.
- It is the first trading platform with a graphic user interface. Earlier platforms only showed a monitor full of numbers, which, although intelligible to the trader, were incomprehensible to the inexperienced user.
- Oanda is the first, and so far the only, currency trading platform which is open 24 hours a day, seven days a week.
- Oanda is the first fully automatic platform. This allows the transaction costs to be extremely low, and Oanda can offer a single currency rate independent of the volume of transactions.
- At Oanda the interest is calculated and credited from one second to the next. The banks do that once a day and only credit interest if a position is held overnight.
Oanda is a good example of how a company can profit from new opportunities and get ahead of its competitors. The new technology and the low cost of transactions have, however, not only made a very modern financial platform possible, but also a completely new science: so-called high frequency finance.
- High Frequency Finance
In order to understand and if possible even predict fluctuations on the financial market, experts are dependent on models. Which results a model provides depends on, among other things, the scale that is used. If, for example, we observe the world's surface from a distant point we are shown quite a different picture to what we see if we move closer to it.
The financial market models work in a similar way: some obtain a bird's eye view and consult data of the months and days to assess movements in prices. The others zoom in closer to what is happening to the prices and are based on hours or even seconds.
A model is a simplified image of reality. Conclusions as to the behaviour of the area examined can only be drawn when the model depicts reality with sufficient precision.
Conventional models of the mathematics of finance, most of which are based on the data of the day, assume that the yield of an asset is normally distributed. The normal, or Gaussian, distribution is the most important of all probability distributions and goes back to the German mathematician Carl-Friedrich Gauss. As a graphic this distribution is depicted as a "bell-shaped curve".
Numerous observations can, indeed, be surprisingly well defined using the normal distribution. Doctors use it in the form of growth tables for infants and young children, scientists in determining observation errors or bankers to optimise the risk of investment portfolios. However, it does not provide a good image of reality on the financial markets, as the past has shown.
Experts have long criticised the fact that large-scale slumps occur more frequently on the stock exchanges than the normal distribution implies. For the latter assumes that most price changes are very small. Only very few are large – and the bigger they are, the more improbable they are. An event such as the Dow Jones crash in 1987, but also dramatic fluctuations in the last few decades, cannot be explained by the normal distribution. The bell-shaped curve therefore has to be corrected if it is to be applied to the financial market. The experts talk about so-called "fat tails": the sides of the bell are thicker than they are in the normal distribution. Negative and then very high yields are therefore more probable than the normal distribution postulates. But that also means: whoever relies on the normal distribution greatly underestimates the risks on the financial markets.
Conventional financial market theories tend to refer to extreme events as exceptional cases and fade them out. But it is precisely these extreme events which are decisive for profit and loss, and not the "normal" price fluctuations. Benoît Mandelbrot, the founder of fractal geometry, has therefore chosen quite a different approach. He tries to depict exceptional price movements with the help of the fractal theory.
Unlike Euclidian geometry, fractal geometry does not deal with simple forms such as straight lines or circles. It describes complex structures and phenomena which occur similarly in nature, for example in coastlines or mountain ranges. Fractals are self-similar, that means that every part of a fractal figure is, when suitably enlarged, similar to the whole object.
Mandelbrot recognised such a self-similarity when he examined fluctuations in the prices of cotton over a period of more than one hundred years. No matter whether he considered one day, one week or one month: they all appeared to be similar.
High frequency finance makes use of this phenomenon. High frequency means that it is not daily data that are measured and evaluated, but every single change. So if a rate changes, for example, every three seconds, that produces, using high frequency, 25,000 pieces of data a day – that is as many as are collected in one hundred years by conventional methods. It used to be impossible to store and analyse such enormous quantities of data. Present-day technology, however, has made it possible to examine periods of time as small as you want and compare them with one another.
In doing so it was noticed that the shorter the period of time, the greater the volatility. Within one hour the data vary much more considerably than in one month. And it has been ascertained: there is a constant mathematical connection between the volatility in the short-term and the long-term area. But that also means: if we know the short-term volatility we can draw conclusions from it for the long-term.