Optimal Inventory Management for a Retail Foreign Exchange Dealer

In this work I explore how dealer, who hold the opposite positions against all traders, can optimize his inventory management. For this purpose, I analyzed the components of dealer’s profit, especially component associated with future exchange rate changes. After this, based on different available inventory management strategies and principles of diversification an optimal strategy for inventory management was derived. Each theoretical model used in the paper is tested on unique data set provided by a large retail FX dealer that contains private information about 7 million trades executed by 22 000 traders from 2011 to 2013 years. According to empirical results, traders don’t either lose or win due to exchange rate changes. The main source of dealer’s profit is transaction costs. Moreover, a dealer can improve his risk adjusted return by using combination of inventory strategies.