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December 16, 2011

Algos: Better, Faster... Fewer

Top Stories in 2011

By James Armstrong

For the past several years, buyside traders have been consolidating their algorithms, paring back the number of tools on their desktops. During 2011, that process accelerated even further, with many firms deciding to cut back to just a handful of algos, often with each one tailored to specific needs.

"People are trying to get from maybe 14 or 15 algorithms per broker to something more like four," said Todd Lopez, managing director and co-head of Americas sales at Goldman Sachs Electronic Trading. "I think four has kind of been the magic number that we've seen."

Lopez said clients were overwhelmed with different options and wanted to simplify how traders access various strategies. The ability to customize algos has been critical to limiting the number of tools traders use, he added.

Customization has not ended with specific algos for different desks. Rather, firms are trying to suit algos to the particular needs of each trader, said Peter Sheridan, vice president and head of algorithmic distribution for the Americas at Goldman Sachs Electronic Trading.

"What we find is, Trader A might have a very different need from Trader B," Sheridan said. "The idea is not just to customize on a firm-wide level, but to customize right down to the individual-trader level."

Sheridan stressed that algo providers are not reducing the number of strategies they offer, but are trying to drill down and target specific strategies for individual clients. After a while, too many offerings can become nothing but noise to traders, he said.

Nitin Gambhir, chief executive officer of Tethys Technology, said the move toward fewer, more customized algos is all about making trading desks more efficient-and more profitable.

"There's this tremendous move happening where clients are getting more and more sophisticated, and what they want is the algo parameters to be tweaked to ensure maximal use of capital," Gambhir said.

Algo providers have to customize their products if they want their customers to get the best execution, he said.

As the market has gotten volatile, the natural response has sometimes been to bypass algos altogether and move to more hand management of trades. That, however, can put traders at a disadvantage, said Dan Hubscher, who leads capital markets for Progress Software.

Hubscher said prepackaged algorithms always need to be tweaked when the market changes, because they tend to work on a set of assumptions that can become obsolete when there is a major shift in trading.

"If you don't have the power to change those in reaction to market events, you're stuck," Hubscher said. "While manual trading might feel a bit safer, you're going to be behind the people who are still in the market trading automatically, who have the power to change their algorithms very quickly, because they have customization tools."

He said when the market changes in a slow or predictable way, it is easier for a prepackaged algo to keep up, but when there are massive jumps like those we saw this summer, the ability to quickly customize algos becomes more important.

So while the number of algos on a desk might be declining, the algos that are there must be the most sophisticated available, not only tailored to meet the needs of individual traders, but also flexible enough to adapt to rapidly changing market conditions.


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