Documente Academic
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Documente Cultură
Algorithmic trading
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Algorithmic trading
Foreword
ifferentiating between the algorithmic trading offerings of brokers
D remains a problem for the buy-side. At the same time, brokers are
searching for ways to achieve competitive edge and raise the profile of
their algorithmic trading capabilities. These issues have to be overcome to
realise the exponential growth that is forecast for algorithmic trading.
The TRADE in association with leading industry participants drawn
from the brokerage and vendor communities has set out to bring clarity and
thought-leadership to the issues that are driving developments in the algo-
rithmic space by publishing ‘A buy-side handbook on algorithmic trading’.
Part 1, ‘Market and mechanics’, examines what is driving the growth of
algorithmic trading, focusing on the rapidly evolving shape of the market.
Insights are offered into how algorithms work and the relative merits of
broker-driven versus broker-neutral algorithms are quantified.
Part 2, ‘Honing an algorithmic trading strategy’, highlights the issues
that buy-side traders must address once the decision has been taken to
adopt an algorithmic strategy. Selecting an appropriate trading bench- 3
mark, the importance of anonymity to stem information leakage, applying
stealth through sophisticated gaming theory, and customisation of broker
algorithms are all addressed here.
Part 3, ‘Quantifying and enhancing value’, focuses on measuring and
interpreting the performance of disparate broker algorithms, the value
added through independent third-party transaction cost analysis and the
role of technology in enhancing market access.
Part 4, ‘Emerging trends and future direction’, covers ‘next generation’
algorithms, focusing on implementation strategies for basket trading and
the shape of the market going forward, when competition and increased
buy-side demand will call for a higher order of intelligence in engineering
algorithms.
The handbook is completed with a guide to broker algorithms, containing
details of individual broker offerings and including information on the
range of benchmarks available, levels of customisation, performance
measurement and connectivity options. ■
John Lee
Editor & Publisher
The TRADE
Contents
Part 2:
Part 1:
Honing an
Market and
algorithmic
mechanics
trading strategy
page 9 page 41
Chapter 1: Chapter 4:
Algorithmic trading – Choosing the right algorithm
Upping the ante in a more for your trading strategy
competitive marketplace
Wendy Garcia,
analyst,
TABB Group
Tracy Black,
executive director,
European Sales Trading,
UBS Investment Bank
4
page 21
Chapter 2:
Understanding how Owain Self,
algorithms work executive director – Equities,
UBS Investment Bank
Dr Tom Middleton,
head of European
Algorithmic
Trading, page 51
Citigroup
Chapter 5:
Anonymity and stealth
Richard Balarkas,
global head of
AES™ Sales, CSFB
page 29
Chapter 3:
Build or buy? page 59
Chapter 6:
Allen Zaydlin, Customising the broker’s
CEO, algorithms
InfoReach Richard Balarkas,
global head of AES™ Sales,
CSFB
Contents
Part 3: Part 4:
Quantifying and Emerging trends and future
enhancing value direction
page 67 page 97
Chapter 7: Chapter 10:
Measuring and interpreting the performance of Basket algorithms – The next generation
broker algorithms
page 107
Chapter 11: 5
page 79 The future of algorithmic trading
Chapter 8:
Making the most of third-party transaction
analysis: the why, when, what and how?
Robert Kay,
managing director,
GSCS Information Services Carl Carrie, Andrew Freyre-Sanders,
head of Algorithmic head of Algorithmic
Trading, USA, Trading, EMEA ,
JP Morgan JP Morgan
Robert L Kissell,
vice president,
page 89 Global Execution Services,
Chapter 9: JP Morgan
Enhancing market access
Appendix
page 115
The TRADE guide to broker algorithms
Mark Muñoz, Mark Ponthier, director –
senior vice president, Engineering, Automated
Corporate Development, Trading Systems, page 130
Nexa Technologies Nexa Technologies Contact information
9 Chapter 1
Algorithmic trading –
Upping the ante in a more competitive marketplace
21 Chapter 2
Understanding how algorithms work
29 Chapter 3
Build or buy?
■ Chapter 1
Algorithmic trading –
Upping the ante in a more
competitive marketplace
What will fuel the growth in algorithmic trading, and what impact
will the widespread adoption of algorithms have on the direction of
order flow?
Wendy Garcia*
entered into the OMS, or import- rithm links, double the number of
ed into Excel and then uploaded fundamental and mixed firms.
to the OMS. In addition, third- The automation of almost every
party applications may not offer process is a key component to the
all the variables of a direct con- quantitative business model.
nection. Large firms, defined as
those with over $50 billion in Algorithmic trade strategies
assets under management, are In a short time period, the buy-
twice as likely to have OMS algo- side has graduated from basic
rithm links as smaller firms, or users of algorithms to fickle
those with fewer than $10 billion clients, growing more selective of
in assets under management. the algorithms they deploy and
Tighter integration between even building strategies around
the buy-side and sell-side trading them. The buy-side now is ques-
platforms continues at breakneck tioning with more frequency
speed. As the number of relation- where and how algorithms can
ships decreases, the percentage of add value to the trade process. As
brokers connected to the invest- more options are made available, 13
ment manager’s order manage- such as increases in algorithmic
ment system is rising. Indeed, trade options and crossing net-
connecting to the OMS is a works, the buy-side trader is
requirement for doing business. maintaining growth in control
For all the benefits of electronic over its order flow. Indeed, it is
trading, the downside for brokers noteworthy that the buy-side is
is that the OMS/FIX infrastruc- actually using a method to choose
ture is the stepping-stone to alter- which algorithmic model to use
native execution vendors and has for particular trades at this point,
been an integral cause of the liq- given the use of trial and error a
uidity shift. TABB Group has year ago (see Exhibit 1 overleaf).
found that quantitative firms are TABB Group can cite several rea-
deeply engaged in optimising the sons for this progression. With
trading process, not surprising some measurable time under their
considering they traditionally belts in using algorithms, traders
have a broader knowledge base are now better equipped to use
about how the algorithmic trade historical information from pre-
systems function, thereby increas- and post-trade analysis with
ing their usage comfort level sig- enough confidence to develop
nificantly. Buy-side quant firms trade methodologies based on past
on average have five OMS algo- performance. It follows logically
Trader’s PM 18%
discretion
Experiment 57%
TCA 16%
Order 15%
objectives
Analysis 17%
Stock 13%
characteristics
Market 11%
conditions
Trading strategy 17%
Liquidity 11%
As any 9%
destination
Simple orders 9%
Flexibililty 7%
2005 2004
Response:
65%
14
Source: TABB Group study ‘Institutional Equity Trading 2005: A Buy-Side Perspective’
that the more the industry learns sophistication. Each strategy has
about different algorithms the its own pros and cons, and each
more often we will see implemen- one must be measured against its
tation of strategies incorporating own benchmark. As firms become
algorithmic trade models. more sophisticated about algo-
Secondly, as algorithm use grows rithms, their demands for more
more pervasive throughout the flexible, customised products will
industry, the race to the top will increase. Quantitative shops and
be based on differentiation and some large firms are increasingly
ability to disguise intent to pre- building in-house technologies in
vent gaming. This high level of an attempt to develop customised
competition raises the bar for all proprietary algorithms that are
algorithm providers and can pro- better suited to their direct needs,
pel the ones that are first to offer rather than relying on their
this to a role of market leader. brokers.
The number of strategies However, most firms still are
employed by a firm is a good unable to break entirely free of
proxy for its level of algorithmic their brokers for algorithmic trad-
Anonymity 18%
Ease of use 9%
Best execution 9%
Control 7%
Solves fragmentation 7%
Response:
Hit benchmarks 7% 65%
16
Source: TABB Group study ‘Institutional Equity Trading 2005: A Buy-Side Perspective’
Understanding how
algorithms work
Where does time slicing and smart order routing end and randomising
your orders through complex algorithms begin?
Dr Tom Middleton*
Quantitative algorithms
VWAP Attempts to minimise tracking error while maximising performance
versus the Volume Weighted Average Price traded in the market.
TWAP Aims to match the Time Weighted Average Price. Similar to simple
22 time slicing, but aims to minimise spread and impact costs.
Participate Also known as Inline, Follow, With Volume, POV. Aims to be a
user-specified fraction of the volume traded in the market.
MOC Enhanced MOC strategy that optimises risk and impact, possibly
starting trading before the closing auction.
Implementation Shortfall Manages the trade off between impact and risk to execute
(aka Execution Shortfall or as close as possible to the mid-point when the order is entered.
Arrival Price)
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Build or buy?
What are the relative merits of broker-driven versus broker-neutral
algorithms? Understanding the trade off between cost and
performance
Allen Zaydlin*
Pros
■ Customised functionality not
currently available from other
level of commoditisation that sources.
has occurred with certain ■ Quicker ability to modify.
■ Tighter control.
execution models and the
depreciation in their relative Cons
■ Bear unscalable expense of
value.” infrastructure, development and
enhancement effort.
■ Risk of failure achieving the exe-
Off-the-shelf cution performance objectives.
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