Challenges for algorithmic execution
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Challenges for algorithmic execution. Gordon Baker. Agenda. Context Research To do. Some definitions Execution vs. trading. Execution No choice of asset, direction or quantity Usually intra-day or good for day orders Trading … everything else Market making Arbitrage

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Agenda l.jpg
Agenda

  • Context

  • Research

  • To do


Some definitions execution vs trading l.jpg
Some definitionsExecution vs. trading

  • Execution

    • No choice of asset, direction or quantity

    • Usually intra-day or good for day orders

  • Trading … everything else

    • Market making

    • Arbitrage

    • Model based trading


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A brief history1980s

Technique

Significance

Market structure (electronic order books) determines spread of automated strategies

  • VWAP, TWAP and participation strategies

  • Empirical approaches to market impact


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A brief history1990s

Technique

Significance

ITG is first algorithmic brokerage

1997-2000 day trading: everyone became a model driven trader

  • Bertsimas & Lo 1998

  • Further gaming countermeasures


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A brief history2000s

Techniques

Significance

Credit Suisse launches AES in 2000

DMA and algorithmic execution account for 50% of NYSE turnover

Some broker-dealers have 80% of order flow executed by algorithmic strategies

  • Landmark research

    • Almgren & Chriss 2000

    • Almgren 2001

    • Kissell, Glantz & Malamut 2003

    • Kissell & Malamut 2005

  • Arrival price strategies

  • Portfolio strategies


Algorithmic execution strategies a broad classification l.jpg
Algorithmic execution strategiesA broad classification

Completing

Non-completing

Participation

Relative value

  • Quantities

    • VWAP

    • TWAP

  • Participation rates

    • Arrival price or shortfall


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Where we are now“Algorithms are only good for liquid stocks”

Broker-dealers

Investors

Broker-dealers algorithms used for 15-30% of orders

Increasing addition of constraints to orders

Consequence: completing strategies become non-completing

  • Widespread use of algorithmic execution, either directly or when unwinding

  • Brand explosion of strategies


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Execution schedulesResearch has provided the benchmarks


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Execution models

Strengths

Weaknesses

Assume perfect markets

Do not address tactics or order placement decisions

  • Mathematically sound approaches to optimising variance

  • Common ground for investors and broker-dealers


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Other academic contributions

  • Econophysics

    • Models for non-gaussian returns

    • Minority games

  • Behavioural finance



The extremes for algorithmic execution volume and trade frequency within the ft se 100 l.jpg
The extremes for algorithmic executionVolume and trade frequency within the FT-SE 100


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The well behaved …High trading frequency – low volume variance


And the not so well behaved low trading frequency high volume variance l.jpg
… and the not so well behavedLow trading frequency – high volume variance


Even the more liquid bp l until mid november 2006 l.jpg
Even the more liquid …BP.L until mid November 2006


Can surprise bp l traded twice its mean daily volume on november 17 l.jpg
… can surpriseBP.L traded twice its mean daily volume on November 17


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CopingTowards a common understanding of behaviour

  • Median curves?

  • Volatile daily volume has no effect for completing strategies constrained by time

  • Prediction of relative weighting?


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Challenge #2

Execution Micro-economics


Order submission the fundamental state model is simple l.jpg
Order submissionThe fundamental state model is simple

LIM

WAIT

FAK


Order submission some of the microeconomics l.jpg
Order submissionSome of the microeconomics



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Algorithmic execution

  • One of the major execution methods

  • Contribution from research is clear

  • More is needed to keep the mutual expectations of buy- and sell-side in line

  • Two challenges today

    • Turning attention on the volume dimension

    • Formalising the different levels of execution model


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Algorithmic execution

Data provided by

Analysis tools

Further information

http://www.gbkr.com


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