A "Buy Side Story"

In my previous posts, I briefly brushed upon the genesis of algo trading and opined on the probability that most buy-side desks will inevitably adopt a workflow utilizing some form of algorithmic strategy.

To better qualify this argument, a definition of the term "algo trading," is in order: "Algorithmic trading defines any systematic execution logic applied to an order at any point from inception until it's acknowledged by a source of liquidity."

To further define buy-side algo trading, we need to distinguish order types against a backdrop of broker interaction:

1. High Touch Orders: Are orders that are sent electronically to the sell-side with the expectation that a broker/trader will use discretion to add value to the execution process.


2. Low Touch: Are electronic orders that are subjected to some form of a sell-side algorithm (e.g. smart order routing) or the possibility of some form of human involvement that might introduce latency into the execution process.


3. No Touch: Are electronic orders that flow uninterrupted from the buy-side to a source of liquidity. Algorithms if any, are applied before the order is acknowledged by the sell-side.

No Touch orders are widely referred to as DMA (Direct Market Access) orders. Generally speaking, DMA orders are favored by the "Do-it-yourself and don't pay the middleman more than you have to," aficionados. Those are typically hedge fund managers and buy-side desks that are actively managing their execution costs, among other things. Interestingly enough, DMA started its life as a retail-trading feature (which to some degree, blurs the lines between the No and Low touch definitions since most brokers do apply some form of trading-limits and/or margin-validation logic against DMA orders).

Based on the definition above, I would also bundle buy-side crossing networks into the algo genre (others might disagree). From a buy-side desk perspective, traders would ideally expect their OMSs (order management systems) to provide for the ability to: a) Manually work an order (good old phone trading), b) Anonymously locate and allow for crossing a good sized block and finally c) Slice/carve/sweep orders based on programmatic rules and/or human intuition.

Last I checked on buy-side OMS capabilities all three could possibly be achieved with a great degree of jigging and duct-taping of several pieces that are not fully integrated. Ultimately somebody somewhere will come up with a decent buy-side broker-independent OMS that can keep up with the changing landscape. In all likelihood this system will have to borrow a great deal from a sell-side equivalent, which favors a complete unknown on the current buy-side vendor list (e.g. here). For the most part, the traditional buy-side vendor heavyweights are not being aggressive enough and are mostly relying on strategic relationships with brokers (here) and (here) rather than grabbing this bull by the horns and getting on the leading edge of this wave. Shades of a possible repeat to how tentatively then frantically they reacted to supporting electronic (FIX) trading not so long ago.

Furthermore, it's my opinion that to have a successful Low or No touch algo trading strategy, practitioners have to get into the habit of creating or at least tweaking algorithms into their own unique trading ideas. Canned or broker provided algorithms, will most definitely produce the exact opposite of the desired effect. For the most part they should be viewed as nothing more than analytic or marketing tools meant to attract order-flow business. Accordingly, the next wave of upheaval on the trading desk will become tilted more towards techno-savvy traders. Traders who can program their systems to do more than direct orders from point A to point B. How technically oriented becomes a function of how well designed and algo-scripting-friendly the next generation of OMSs prove to be....