Robert Hegarty
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Reinventing Trading Venues: How AI Can Help Create a More Efficient Market

In this whitepaper shared with Traders Magazine, the Hegarty Group examines how artificial intelligence and machine learning can help traders execute more efficiently.

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June 30, 2003

The Sudden Success of Program Trading: Does a new trend mean the demise of block trading?

By Gregory Bresiger

Average buyside traders - many without technical computer expertise - now look favorably at portfolio trading. "Program trading offers efficiency to the buyside in terms of managing risk and routing orders," said Enrico Gaglioti, head of global program trading at Goldman Sachs. "Now, more than ever, transaction costs and execution are being more closely looked at with regards to performance," said Greg Tusar, who runs the TradeFactory, Spear Leeds' front-end trading operation. (Spear Leeds is an affiliate of Goldman Sachs.)

Buyside Desks

Program trading is seen as cost effective by buyside desks. The typical commission charged to institutional accounts by sellside firms for a program trade is around 1.5 to 2 pennies a share at the largest firms. That's compared with 4.5 cents to 5 cents a share at many large desks executing a block stock order.

"In today's marketplace, where the use of large block trading is dropping, buyside desks have really been forced to piece their orders into the marketplace a lot slower and in smaller increments," said Mook.

Factors driving this move toward portfolio trading include the trend of smaller trades, which are less efficient and more expensive for firms than executing entire portfolios. For example, Nasdaq's average trade size has dropped from 1,712 back in 1997 to just under 600 shares recently, according to Birinyi Associates. The same has been happening at the Big Board. The average trade size has gone from about 1,800 to some 500 in the same period, Birinyi reports. Smaller trades mean desks - like it or not - must find a way to become more efficient, trading executives say.

Critical Weapon

Indeed, portfolio trading has become a critical weapon for margin squeezed desks battling for decent profits in a bear market.

Program trading, which is enormous on the listed markets, is also on the rise on Nasdaq. "If you're doing a lot of S&P 500 index, large cap names, then you're doing portfolio trades on listed exchanges," Mook said. "If you're using a lot of small caps, then it's Nasdaq."

Both the buyside and sellside are benefiting from program trading.

"We are seeing more and more sellside firms looking to open program trading desks," said Vijay Kedia, a former Bear Stearns official who set up FlexTrade Systems, a seller of program trading software. Kedia, in a recent interview with Traders Magazine, said that previously program trading was a strategy only used by elite desks. But now even the regional brokers, the second tier brokerages, consider setting up these desks.

"Everyone is looking at program trading. Which speaks to demand on the buyside to send programs to the sellside," Kedia said.

That's because, in some cases, program trading is a necessity for desks that are trying to survive declining revenues.

"Commissions look so meager or fragile," said Jay Bennett, an analyst with Greenwich Associates, "that they are worried about making any money whatever happens to markets - and they certainly can't make any with an overly specialized sales force."