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Anatomy of the Perfect Trade

Traders Magazine Online News, February 7, 2019

Jack Miller

What does the perfect trade look like in 2019?

Two hundred years ago, it might have been two guys under the proverbial buttonwood tree, calling out bids and offers and exchanging hand-written pieces of paper. Today trades take place in the blink of an eye (faster, really), and mostly on a server in a data center in a New Jersey swamp.

But in spite of all this progress, surveys consistently show that a significant percentage of the buyside is unhappy with the electronic trading tools, venues and routing options that are available to them. Algorithmically-driven automation would seem to offer a way to streamline and simplify trading, but comes with its own set of complications. Algos can process more information faster than a human ever could, but are only as good as the instructions they are given. They may emphasize urgency or caution;  act carefully or aggressively; attack liquidity or avoid impact; be opportunistic or stick to the schedule – all appropriate behaviors depending on the situation, and all factors which impact the outcome of a trade. They don’t act in a vacuum, they don’t by themselves guarantee best execution, and they don’t always provide the level of accountability demanded by the buyside where control and detailed transparency in order routing are paramount concerns.

A “one size fits all” approach to the use of algos has taken hold in some areas of the market, reflected in the tendency to plug the parameters of a trade in and let it run. This rarely leads to an optimal outcome. Market conditions can change quickly, and no single algo can account for all the potential variables. You need another algorithm to decide which algorithm to use – or input from a human being.

To that end, a 2013 survey showed a keen interest on the part of the buyside in combining high and low touch approaches. Six years later the interest is still there, but there is recognition that the implementation has often been imperfect. The question of how and when a human trader should intervene continues to be debated, while in some shops technical and human expertise remains effectively siloed making interaction difficult.

The reality is that too many options are leading to a kind of paralysis. As electronic trading and market structure become more complex and advanced technologies allow for more detailed customization, it’s increasingly challenging for a desk from both a level of understanding and a workflow perspective. The problems the industry is trying to solve end up manifesting themselves again due to information overload – the paradox of choice.  In practical terms, traders end up using the wrong strategy for the current trading situation. Best execution remains out of reach.

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