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Conquering Fear in Trading

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August 1, 2013

BEST Algo Forward

By John D'Antona Jr.

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Cowen and Company is making tools available to its buyside customers that it believes will help them when deciding which trading algorithm to use.

The new service marries technology that predicts the price of a given stock in the very short term with technology that switches between several Cowen algorithms. Based on the trader's level of aggressiveness and the expected price swing in the stock, the switching technology picks the optimum trading algorithm.

William Lishman, Schroders Investment

The net result is Best Execution Switching Technology or BEST, an algorithm that reacts and adjusts in real time on behalf of a buyside trader's desired trading strategy, said John Cosenza, co-head of electronic trading at Cowen/ATM. Algorithmic Trading Management, or ATM, is an electronic trading firm Cowen purchased in 2012. This dynamic and automatic functionality replaces the manual process of changing algorithms or trading strategies during the life of a buyside order, Cosenza added.

"BEST adjusts itself dynamically and logically as a stock is traded," he told Traders Magazine. "The dynamic functionality is essentially an evolution of what we've seen buyside traders do manually with different algo suites."

The algorithm has two core components: first, a proprietary short-term alpha model that generates a prediction about whether the stock will go up or down and a measure of confidence of that forecast; and second, switching-engine capability that dynamically changes algorithmic trading strategies such as VWAP, implementation shortfall, etc.

The switching is based upon user inputs for level of aggression, stock price movement, the BEST score and changing market conditions.

Cosenza explained that the algorithm operates by first computing the BEST score from the short-term alpha model for a stock. The alpha model looks at technical and relative value factors in determining a BEST Score, which ranges from -100 for a stock expected to fall in price to 100 for a stock expected to rise in price. As an example, relative value can be defined as the stock price movement versus sector ETF price movement. Then the algorithm processes this score as a factor into the decision-making process, depending on the strength of the score.

The data is presented to the trader, who can then input a number indicating how aggressively the algorithm should be searching for the stock, on a scale of one (least aggressive) to five (most aggressive.) The user-defined "aggression" parameter determines how much of a factor the BEST score plays into the switching engine's decision to switch from one particular strategy to another strategy.

"The BEST algorithm was programmed using information we gathered through dialogue with execution traders and extensive analysis of FIX traffic logs that illustrate customer behavior," Cosenza said.