Every trader needs an algorithm

Issue 03 October 2006
Automated Trader Magazine

New breeds of aggressive algos are being designed for active DMA traders, whilst changes in market structure are making algos essential.

Richard Balarkus

Richard Balarkus, Managing Director and Head of AES sales at Credit Suisse

Credit Suisse’s AES team is currently focused on the needs of the more active trader. Although the use of algorithms has exploded on both the buy side and sell side, Credit Suisse’s AES team was still discovering many experienced traders who reject the use of algos. Chris Marsh, who heads the AES desk in London, said, “Many brokers were pushing algorithmic trading products that were little more than glorified trade scheduling and VWAP tactics. This may suit some but certainly not all styles of trading. In the real world, many traders need to be much more aggressive. They want to get done quickly and participate in available liquidity -- as long as they don’t push or chase prices.”

When the AES team analysed the execution performance of clients using their algos, it found many traders being too passive. For example, the majority of VWAP orders were set to run until the market close, and even strategies focused on reducing impact and
implementation shortfall were being used too passively. “The first algos were very successful at not paying the spread when compared to a human trader, but often it’s not spread costs that matter, but trend and time risk instead. If a trader thinks a stock could move 70bp in the first hour of trading and the spread is 20bp, then if volume is present on the far touch it makes sense to lift a chunk if not all of the far touch and pay the spread,” says Marsh.

At the same time Credit Suisse was trying to determine how to use algos in less liquid names where volume patterns are unpredictable and price correlations between names are weak. “We identified that simply joining the bid in a small amount would make the spread gap and offers disappear in illiquid names. We needed to avoid signaling risk. We also needed to make sure that when liquidity opportunities arose in these names, we got involved”, says Richard Balarkas, Managing Director and Head of AES sales at Credit Suisse. ...