Sell-Side Electronic Trading:
Industry Reacts to New Generation of Hackers | A New Way to Attack Market Data Costs | The Hidden Cost of Trading | In Fixed Income, FIX Is a Post-trade Solution | Algorithms Multiply to Match Trading Strategies |
Algorithms Multiply to Match Trading Strategies
November 21, 2006
Sell-side firms have been unveiling new algorithms at an almost dizzying pace, making it clear that electronic trading continues to grow in complexity as its usage increases. These strategies include liquidity-seeking models that swiftly access the growing number of dark pools and crossing networks, and algorithms for small-cap stocks, foreign exchange and large portfolios. There are also adaptive algorithms, which are designed to respond to shifts in the market as a live trader might.
A big reason for the increased number of products is that usage of, and demand for, algorithms on the buy side shows no sign of letting up. According to Aite Group, a Boston-based research firm, 33 percent of total equities trading volume flows through algorithms, up from 15 percent a year ago. Aite forecasts that the proportion will rise to 53 percent by the end of 2010. "Algorithms are being used by an incredibly expanded base of clients," noted Brad Bailey, a senior analyst at Aite. "It's not just hedge funds anymore."
Similarly, Westborough, Mass.-based research firm Tabb Group projects that the number of shares traded via algorithms could more than double after the Securities and Exchange Commission's Regulation National Market System goes into effect in February. While many buy-side traders will still execute trades manually, when they do have an order that they want to execute with an algorithm, they will only use something that they deem to be state of the art, wrote senior analyst and consultant Adam Sussman in a Tabb Group report earlier this year. This puts pressure on brokers to continue to innovate.
Sussman also noted that in the current electronic trading environment, there is a lack of differentiation among offerings, and this could pose a threat to customer loyalty. As a result, more sell-side firms are feeling pressure to set themselves apart. "It's extremely competitive," said Tom Bok, SVP at Lehman Brothers Holdings in New York, which said it is launching this month a liquidity-seeking algorithm over its Lehman Model Execution platform. The bank also offers an advanced-strategy tool kit to make it easier for buy-side traders to customize Lehman's algorithms, and it is touting improved integration of algorithms with analytics via a new dashboard feature.
Timothy Reilly, managing director of North American electronic execution sales at Citigroup Global Markets, views liquidity-seeking algorithms as "the third generation of algorithmic offerings and the most challenging to produce from a data management, infrastructure and financial engineering point of view." The first generation of algorithms was based on common benchmarks such as volume-weighted average price. The second included strategies such as implementation shortfall, which Reilly described as being more complex and largely focused on price goals.
Liquidity Seekers
In August, after a three-month development effort involving 14 people, Citi released Dagger, which is designed to aggressively capture liquidity on electronic communications networks and exchanges without revealing signals to other market participants. Reilly said this algorithm competes with Credit Suisse's Sniper and Guerrilla algorithms as well as Ambush from Banc of America Securities. At the same time, Citi also released Scouter, which searches for hidden liquidity across alternative trading systems and major exchanges. Scouter, like Guerilla, is engineered for traders seeking consolidated liquidity.
Other liquidity-seeking offerings include Goldman Sachs & Co.'s Sonar, which was released this past summer, and JP Morgan Chase & Co.'s Aqua and Arid, unveiled in September. Aqua is designed to trade large orders in liquid markets, and Arid is intended to be used for illiquid securities such as small-cap stocks. Both find liquidity by sweeping a total of eight dark books.
