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September 10, 2007

Volatility Leaves Traders Stirred But Not Shaken

By James Ramage

Midway through last month's wreckage, traders saw a common scenario unfold: Find a good spot to trade a stock, buy or sell at that price, then watch it jump or plummet 10 percent within five minutes or so.

The volatility sparked by subprime mortgage-backed securities that tore through markets in July and August shook the financial world. The market gyrations created challenges for equity trading, but traders say there was mostly an abundance of liquidity.

Buyside firms said they used more limits with algorithms and saw a higher percentage of order flow trade in dark pools. To be sure, some suggest that the firms that best handled these markets already relied heavily upon electronic trading; those that didn't had a much tougher time. Sellside firms, meanwhile, saw record volumes. Both sides said their systems and Wall Street's infrastructure faired well during a period that each described as dramatic, but not traumatic. "All things considered, I think that the exchanges and the technology platforms held up quite well," says Tom Wright, global head of trading at Sanford C. Bernstein.

On August 15 and 16, the Chicago Board Options Exchange's Volatility Index or VIX jumped past 30, after a long tenure in the low- to mid-teens range for most of the past three years. Kevin Connellan watched anxiously from abroad as the market whipsawed. But the equity-trading desk he leads at Northern Trust Global Investments held its own, Connellan says. "I don't think you walk away from algorithms," Connellan says. "You just use them more intelligently and use limits. You dictate to the algorithm how you want to trade."

His initial hunch was that order flow increased in dark pools. As volatility increases, Connellan says, traders are more nervous about showing their hand. Others concur.

"I never saw so much liquidity in dark pools," says Ted Oberhaus, head of trading at Lord Abbett & Co. "I never saw so much liquidity in our stocks." Kirk Allen, head of trading at NWQ Investments, says most traders lowered their trading size in the crossing networks as a hedge to protect against volatility. "If you typically traded 250,000 shares at a time in the crossing networks, it made sense to lower that amount to 50,000 or 100,000 shares," Allen says.

At the Bridgeway Funds desk, the block trades business was slow during the August spikes, says Dick Cancelmo, trading team head. As long as volatility is factored into trading properly by, say, taking smaller bets, one can find opportunity, he says. "If you're trading one million shares of a stock, that trading range is going to be larger than it was a month earlier," Cancelmo says.

During the tumultuous period, Credit Suisse broke firm volume records, says Dan Mathisson, head of Credit Suisse's Advanced Execution Services-as did many other firms. Indeed, the industry saw three days that exceeded 10 billion shares traded, and several more days greater than 9 billion shares, Mathisson says. The volumes were so substantial that illiquid stocks had days where they traded "like IBM," he adds. "It's been a very easy period to move in and out of positions, like your mid-cap names and smaller big-cap names," Mathisson says. That the system withstood the stress "shows the success of electronic trading and the tremendous infrastructure that's been built up throughout Wall Street," he adds. "It's just inconceivable that Wall Street would have been able to handle this kind of volume even 18 months ago." Lord Abbett's Oberhaus commented about the wild ride some stocks took, down "8 or 10 percent on absolutely no news." Gregory Cavallo, managing director at LaBranche's Institutional Group, saw this, too. "There's a lot more volatility that's based in the market naturally now," he says. "With a lot of the NYSE being electronic, and the uptick rule for short sales not being there, I think that contributed to the volatility."