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April 1, 2004

A Program Trading Weapons Race

By Peter Chapman

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Brokers and Vendors Launch More User Products and Services

The boom in program trading has sparked an arms race among the major technology suppliers. Already this year, three of the biggest providers of basket-trading systems have come out with new features and functionality. Spear, Leeds & Kellogg, a broker, has added pre-trade analysis and a sophisticated algorithm. InfoReach, a vendor, has added a pairs trading module. And Portware, also a vendor, announced an alliance with Lava Trading to offer smart routing and connectivity.

The rush to enhance these systems is driven by intense competition in the formerly cozy and arcane world of electronic basket executions. Where once Spear, Leeds and Investment Technology Group held sway, now at least ten firms are battling for market share. The surge comes as more buyside shops look to aggregate order flow, or more efficiently process their existing baskets.

Suppliers of program trading technology are split into two camps: vendors and specialty electronic brokers. The most prominent vendors are FlexTrade, Portware and InfoReach and Aegis Software. The brokers are Spear, Leeds, ITG, UNX, Instinet, Bloomberg, Belzberg and BNP Paribas.

The vendors license systems, installing the hardware and software on users' premises. The brokers act as service bureaus, giving customers access to the technology over telecommunications lines. The software and hardware remain on their premises while they charge per share.

Customers are do-it-yourselfers on both the buyside and the sellside who prefer to trade their own baskets instead of sending them to brokers' program desks. The traditional users are quantitative money managers, indexers, sellside program desks and sellside prop desks.

The growth of the hedge fund industry has introduced a new set of customers. Hedge funds, like the sellside prop desk, engage in such strategies as index arbitrage, merger arbitrage, and statistical arbitrage.

In the past few years, more plain vanilla money managers have turned to program trading to cut transaction costs. The advent of penny ticks made transacting blocks more difficult. The market downturn hurt performance.

Some are working their own orders, but a great many are asking brokers to do it for them. That has brokers of all stripes setting up program trading desks. That, in turn, has provided the technology suppliers with a new sales outlet.

In the race to offer the hottest functionality, ITG is clearly the name to beat, according to some pros. The aging specialty broker has long been known for some of the most sophisticated program trading technology on the Street. Its QuantEx system was considered the gold standard that allowed it to capture the buyside quant market.

Now, however, the rest of the pack has caught up. Much of what ITG offers has been replicated by its competitors. ITG's "client site" division has been hit hard. Last year, the group saw its revenues drop $34 million to $77 million.

Systems suppliers tend to split products into three or four modules, each geared to a different trading style. That way, traders only get the windows they need to conduct their strategies.

Spear, Leeds' TradeFactory, for example, gives users four overarching strategies from which to choose: index trading; spread trading; portfolio trading; and delta/gamma hedging. Portware divides its system into three parts: portfolio trading; prop/index trading and position management.

FlexTrade Flexes