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February 16, 2009

Liquidnet Algos Prepare for Crossings

By James Ramage

Liquidnet developed four new algorithms. They include aggressive implementation shortfall, close and multiple VWAP strategies.

Its implementation shortfall strategy, called Adaptive Optimum, balances participation in Liquidnet's pools and the displayed markets. It uses a model that forecasts crossing rates and calculates an optimal exposure time to the Liquidnet pool.

Most trading strategies base their schedules on historical volume profiles, said David Fellah, head of Liquidnet trading strategies. With Adaptive Optimum, the algo forecasts crossing opportunities in Liquidnet beforehand.

"We use historical data from our Liquidnet database to predict the probability of a cross and the size of a cross," said Slava Glukhov, with Liquidnet trading. "And we put that information into our strategies to build a trading schedule that actually balances market impact, exposure to volatility and the probability to crosses."

Two VWAP strategies-Hybrid VWAP and VWAP Blocks-balance market impact against deviation from benchmarks. Hybrid VWAP allows for a moderate deviation; VWAP Blocks allows for a high level of deviation.

VWAP Blocks trades passively in the market at the VWAP rate while maximizing crossing opportunities in Liquidnet pool. Hybrid VWAP determines the right amount of the order to be placed in the network for the client's risk preferences, with respect to the benchmark, Glukhov said.

The Close algorithm reduces the impact of trading at the market's close. If the benchmark is the closing price, it ramps up block participation into the close.

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