Next-Generation Algorithms: High Frequency for Long Only

As the pace of the market and its participants quickens, finding liquidity will become even more of a challenge. The buy side continues to struggle in routing orders, accessing hidden order flow and extracting maximum liquidity at minimum cost from the public markets. Unfortunately, traditional algorithms only offer solutions to some of these problems. Indeed, slicing and dicing large orders into small pieces, using SOR technology to seek out liquidity across venues and using limit orders to hide intent are all valuable mechanisms for actively managing orders. However, the level of sophistication required to trade in today’s market has grown tremendously.

This is not a challenge that the buy side should shirk from but rather embrace. The key to navigating today’s market lies in utilizing lessons learned from high frequency trading. More specifically, the buy side should be mimicking their approach to measuring and minimizing transaction costs, technology infrastructure and reacting to risk limits. A new breed of algorithms are entering the market that utilize this very approach. These algorithms are adopting the techniques of trading outfits who look to profit from the market microstructure rather than treat it as an automatic loss. With the arrival of this practice, the execution landscape is now becoming a level playing field rather than a minefield for long only institutions.

In the past, the buy side may have felt they suffered from an unfair advantage. Today, they can learn from their high frequency counterparts and work with algorithm providers to integrate the similar tactics into their own execution tools. Strategies that take a page out of the high frequency playbook can add measurable value to their overall fund performance. This new era in trading style has begun to fill the gap left by the obsolescence of traditional market making and specialist firms.

Algorithms were at the beginning of the trading progression. As we enter a new age of trading, the innovation of these tools has become crucial in maintaining a competitive edge. Today’s algorithms should be able to execute with the same vigor under the most extreme circumstances as they do in the most mundane of trading days. A simple toolbox with predetermined parameters is no longer enough. Today’s algorithms should not only be focused on executing but providing information on what’s happened in the past and what may be happening in the future so that traders may act on that information instantly.

As this revolutionary stage in the equities market pushes forward, the profile of the market as well as the tools required to navigate through it will continue to change. High frequency traders have passed along a valuable skill set that allows firms to invigorate their trading techniques, intraday strategies, performance reaction, and the way they employ the buy-side trader. However, the true challenge will be in sifting through this next wave of electronic trading technology and selecting the most innovative solutions that are still in tune with long only portfolio objectives.

The TABB Group Vision Note Next-Generation Algorithms:

High Frequency for Long Only gives a detailed description of how a more challenging trading environment and the natural dispersion of high frequency trading techniques has changed the way today’s algorithms are being designed. The report also analyzes why the next generation of algorithms can be utilized by long only institutions. Finally, this vision note describes how algorithmic providers should be continuously adjusting and updating strategies to help clients take advantage of changes in market structure and the way its participants interact.