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Dual Algo Drama

Published in Automated Trader Magazine Issue 13 Q2 2009

Joe Wald, Managing Director at Knight Capital Group and Co-Founder of EdgeTrade, outlines the use of a next generation algorithm that links Benchmark and Smart Order Execution strategies to sell a large position in General Electric

The Scenario: Despite assertions to the contrary by General Electric's senior management, a large conventional US asset manager has become increasingly concerned that the company will miss its Q1 2008 profit number. The manager has been steadily selling down her holding in GE over the past month into a rally that has seen the stock move from around 31.50 to hit a high above 38.00. However, with first quarter results due out tomorrow, the manager is keen to clear out the still substantial rump of her GE position before close of business today. While the stock has come off a couple of bucks in the past seven days, the manager is still anxious to unload her remaining GE at an average price of 36.65 or better. A major obstacle to achieving this is that while GE volume on displayed markets rose strongly through the first three weeks of March 2008, it has since fallen back to around half the peak level of March 20th.

The Asset: General Electric stock. Typical bid ask spread is 0.01 and 100 day average of NYSE volume is 47.3m.

The Challenge: To sell 12.5m GE during the day on April 10th 2008, at an average price of 36.65 or better.

The Algo: The trader will use a combination of two execution algorithms:

• A high level Smart Vtrack volume participation algo that hands off execution to a lower level algo. The algo can include/exclude dark liquidity sources from its activity by leveraging FAN.

• A low level algo with various aggression settings that can search dark liquidity as required and automatically override the maximum percentage participation constraint of the higher level algo if desired by using the Dark Switch and/or I would settings.

The Trader: The trader, who is based in New York, handles most large cap trades for the fund and uses a combination of Market Profile and various proprietary tools to assist in timing changes to execution algorithm parameters.

Figure 1

Figure 1

Source: CQG, inc. © 2009. All rights reserved worldwide. www.cqg.com

8.30am: Although the size of the order approaches 25% of recent daily NYSE volume in GE (so success will be dependent upon effective dark participation) the overall prognosis is not overly negative. After GE reinforced Q1 earnings expectations in March, several other large asset managers have become discreet acquirers of the stock. Therefore there may be significant demand lurking in dark liquidity venues during the session, potentially boosted by the fact that GE's price has been drifting down over the past week.

The price outlook is also reasonable; GE closed last night exactly on its Market Profile control point for the day (as highlighted in Figure 1), indicating that the market was trading at fair value with no significant short term positive/negative bias. In view of this, a key point to watch today will be the first hour's range; if the market subsequently trades below the low of this then there is a strong probability that it will continue to trade down and away from the target execution price.

9.00am: The trader has set the high level algorithm to a maximum of 20% volume participation, an initial limit price of 36.50 and turned on the dark liquidity switch. He sets the lower level algo aggression setting to passive so it will only post on the ask.

9.30am:
NYSE opens below the limit price and immediately starts to trade down, so both algos remain inactive.

10.36am: Short term resistance appears to have developed at the limit price, with the market running up to 36.50 several times in the past twenty minutes; still no trading.

10.44am: (Quantity filled - 92k) GE has finally broken above 36.50 in the last few minutes on reasonable volume. The low level algo has posted successfully several times on the ask.

Figure 2

Figure 2

Source: CQG, inc. © 2009. All rights reserved worldwide. www.cqg.com

11.00am: (Quantity filled - 498k) The market has been trending upwards in the past fifteen minutes, resulting in a steady disposal of stock in displayed markets and a single 115k disposal on KnightMatch. With the market going his way, the trader has opted to raise his limit price to 36.65.

11.50am: (Quantity filled - 1.27m) Price conditions have turned choppy in the past half hour so disposals in displayed markets have been slower. Fortunately this has been offset by two 300k+ disposals on Liquidnet H2O and Level. Average price achieved so far is 36.61. The trader's proprietary congestion measure (highlighted in Figure 2) has reached its intraday trigger level, indicating a possible breakout is imminent.

11.55am: (Quantity filled - 3.03m) Market has indeed broken upwards to a new intraday high, but is currently showing little further momentum.
Disposals in displayed markets have picked up, considerably boosted by several substantial trades on NYFIX Millennium and KnightMatch.

1.02pm: (Quantity filled - 3.82m) GE has been drifting gently upwards over the past hour. Little activity. With the order still a long way from being filled, the trader elects to increase the low level algo's aggression setting to Passive+, which additionally allows posting and immediate or cancel (IOC) orders down to the bid/ask midpoint on dark venues.

1.05pm: (Quantity filled - 4.27m) Critical point approaching. The aggregate Market Profile control point since March 18th (when the market rallied strongly and nearly took out the high for the year) is at 37.04 (see Figure 3), which represents significant resistance.

However, 37.00-37.04 is at the bottom edge of a major Market Profile vacuum in the distribution since April 2nd, when the most recent pullback started (see Figure 4). Therefore if the market can convincingly break above 37.04 it is likely to move rapidly up to the opposite side of the vacuum at 37.44. If it cannot make the break, then in conjunction with the control point resistance it is likely to fall back, possibly sharply.

1.43pm: (Quantity filled - 4.57m) Not encouraging. After flirting with the 37.04 level for around half an hour, the market has backed off. It isn't a dramatic decline, but with a little over two hours to the close and the order only just over a third done, things are not looking great. However, the increased aggression setting is having a beneficial effect.

Figure 3

Figure 3

Source: CQG, inc. © 2009. All rights reserved worldwide. www.cqg.com

Figure 4

Figure 4

Source: CQG, inc. © 2009. All rights reserved worldwide. www.cqg.com


2.17pm: (Quantity filled - 5.39m) Still drifting and time is running out. The trader moves the aggression setting up to Neutral, which allows posting and IOC orders down to the bid/ask midpoint on both public and dark venues.

3.11pm: (Quantity filled - 6.71m) Past the halfway mark at last. Steady disposals in displayed and dark venues now, but still a long way to go.

3.35pm: (Quantity filled - 7.86m) Ouch! GE has dropped some twenty-five cents in the last five minutes.

3.42pm: (Quantity filled - 8.03m) Not good. The market is now trading below the limit price, so neither algo is currently running.

3.49pm: (Quantity filled - 10.32m) Lucky. Clearly quite a few traders saw the recent sharp decline as a buying opportunity and have piled in. The low level algo has managed to dispose of a flurry of large blocks of stock in various dark venues.

With the finish line in sight, a pile of other trades to manage and the average price achieved so far comfortable above the target, the trader decides he can afford to show his hand and pushes the aggression setting to Aggressive+, which allows paying the spread on all venues.

3.54pm: (Quantity filled - 12.5m) Unsurprisingly the increase in aggression setting has had some market impact and GE has come off around fifteen cents. Never mind; the trade is complete at an average price of 36.81.

Which in view of what happens tomorrow morning when GE misses its numbers by a mile, (see Figure 5) is probably just as well…

Figure 5

Figure 5

Source: CQG, inc. © 2009. All rights reserved worldwide. www.cqg.com