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Jared Dillian
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The Liquidity Problem

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May 1, 2011

Sellside Wants Discretion

By Peter Chapman

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Both the HFTs and the brokers listen to signals, but the broker is not able to react to them as fully as the HFT. That's partly due to the disconnect that exists between the portfolio construction process and the execution process on the buyside, Manwani explained.

At the prop shop, the two are closely tied together, if not the same thing. At the money management firm, when the portfolio manager decides to trade, may not be the best time. "There is no feedback loop," Manwani said, "that might pause the portfolio manager. The time scale over which the portfolio manager expects to earn his alpha is very different."

The sellside is further hamstrung because the buyside frequently doesn't divulge the full size of its order. To avoid tipping its hand, the buyside will often just inform the sellside of part of its order. The buyside trader might even spread the full order around to different brokers. This lack of information makes it harder for the sellside to know how fast to trade the order, Self said. They are in the dark as to how aggressive they need to be.

The central difference between the broker and the high-frequency prop shop is motivation. The HFT trades because he wants to. The broker trades because he has to. The HFT has full discretion. The broker does not. This puts the advantage in the HFT's court. "The high-frequency trader has unlimited discretion," Self said. "I don't. That's why he doesn't get gamed anywhere near as much as I do."

 

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