US Institutional Equity Trading 2019 Liquidity: Blocks, Algos, Analytics, and Impact

The world is in transition: political, social, and economic. So too are the markets. Between technological innovation, venue fragmentation, the transition from active to passive, as well as the restructuring of research, commissions are being severely squeezed. More trading responsibility is falling on the buy-side trader, and given the spike in volatility, liquidity has become increasingly difficult, not only to find, but even to piece together through the use of algorithms. Algorithms (algos) have become the most important buy-side trader accessory, outstripping sales traders and capital, while central risk books (CRBs) are becoming an increasingly important tool when market liquidity isn’t sufficient, especially for larger managers.

In recent years the sell-side has introduced several offerings to assist buy side traders with the process of sourcing liquidity and executing trades efficiently. Conditional orders have automated the process of negotiating block trades via a broker. They empower traders to search for block liquidity in multiple block trading venues simultaneously with minimal risk of over execution. The introduction of broker-provided liquidity by CRBs has presented a new source of block liquidity for investors as well. Trading firms can further automate the manual decision-making processes by incorporating their execution and routing logic into a sophisticated suite of algos in the form of an algo wheel.

These innovations are made possible by the proliferation of data and measurement tools, allowing buy-side firms to quantify the economic costs associated with various algos and liquidity sources. By measuring and comparing their routing decisions and execution costs, firms can ensure that they are only trading when and where the outcome is profitable for them. In addition to measuring execution performance, firms are now integrating TCA and routing analysis into their wider decision-making processes and utilizing more data inputs than ever before in order to drive profitability and efficiency.

These tools enable traders to minimize slippage and transaction cost, helping to offset the challenges of declining natural liquidity in the US equities market. While this is an obvious positive for any trading firms, the economics don’t always make sense for the smallest firms to invest in their own technology. While larger firms still have access to preferential treatment from their brokers, and medium firms have budgets to invest in sophisticated technology platforms, the smallest firms must weigh the cost of technology build with the benefits of reduced market impact. For small firms, 2019 will prove to be a pivotal year for technology adoption, as conditionals, CRBs, and algo wheels become increasingly available. Whether or not these firms will be able to use these tools effectively and stay profitable remains to be seen.

US Institutional Equity Trading 2019

For TABB Group’s 15th annual Institutional Equity Trading (IET) report, we interviewed heads of trading at 92 buy-side firms in the first and second quarters of 2019. The results will be published in six parts. In Part 1, we reviewed buy-side views on liquidity, as well as usage and trends pertaining to volatility, block trading, conditional orders, central risk books, algorithmic execution, algo wheels, TCA, and performance measurement.