Commentary: Caveat Trader
Wait - what did that cost me?
Traders Magazine Online News, August 22, 2011
"With great power comes great responsibility." No, that line didn't come from the Spider-Man movies-successful wartime president Franklin D. Roosevelt said it first (and Voltaire did too, before him, but FDR fits better for our purposes). Please note the "wartime" part, because we are in the trenches daily as today's trading environment continues to change. Our arsenal is technology, and broker-supplied algorithms are often the specific weapon of choice.
But what is the end result of using these algos? Trading made easy? Or further marginalization of a trader's skill set? Your call.
Although powerful when used correctly, the available specialized algorithms are frequently rendered barely adequate, because traders may not select the correct parameters necessary to target the desired equity. In an ever more competitive marketplace, a trader is unwittingly putting his order at a major disadvantage if he's not using his algo properly.
Based on research and discussions with many key algo providers, we believe the following scenario is all too common: Traders are increasingly relying on "go-to" desk algorithms supplied by their broker without having been properly educated about how to use them, and therefore risking exceedingly poor execution. The problem usually arises due to the misguided comfort a trader draws from using just one or two desk algorithms. These algos were thoughtfully researched, customized on launch day and are ably toggled "passive" or "aggressive" on the fly.
But after the initial setup, they're put on autopilot because that's simplest (the preset algo hot button is right there), and anyway, the algo has been advertised as providing a certain level of execution quality. Unfortunately, complacence here is definitely a no-no-forensic investigation will likely reveal the execution quality to be disappointing. Many algos are perfectly capable of adequate execution; but it's how they are used-and even more important, when-that can make them ineffective.
Here's an easy example: Returns and fills will always be poor if you're using an unmodified VWAP on volatile stocks-as will other algo flavors in trading situations not adjusted for, no matter how good they're advertised to be.
At several conferences I've attended, in the U.S. and elsewhere, I've heard complaints from providers, brokers and traders from both sides of the desk, stating that many algo users have not been fully educated about everything the products do and how they access the markets, not to mention that they lack the time to learn how to modify them. And even if they do understand their algos, they say, the interfaces can be less than user-friendly, especially if you need to use one quickly-as is the case on hectic market days, when adjustments are most necessary.
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