Cover Story: Keeping Watch
Traders Magazine Online News, May 7, 2012
When it comes time to have a chat with an overly aggressive trading firm, no single group gets more calls than any other, White said. His crew has reprimanded HFTs for abusive latency arbitrage strategies. They have also warned buysiders against using too-clever algorithms.
There are consistent phone calls to all groups, White said, adding that some money management shops house quant groups alongside plain vanilla desks that may use sophisticated trading strategies.
While all four brokers take slightly different approaches to the task of monitoring trading activity, their analyses share one common input: market impact.
Because the proof is in the pudding, brokers analyze the performance of stocks traded by their dark pool customers in the seconds immediately after a trade takes place. If, over several trades, the price consistently moves in favor of one party and against the other, the more fortunate trader comes under scrutiny.
At Deutsche Bank, for instance, the electronic trading team tracks behavior in its Super X (Super Cross) dark pool over timescales ranging from milliseconds to multiple days. We look at how much the price has moved relative to impact expectations and correlated securities, says Jose Marques, global head of electronic equity trading at Deutsche Bank. Every time we trade against a counterparty we learn something about them.
For its part, BofA Merrill eschews simply looking for price changes, or reversions, immediately after a trade. It prefers to examine spreads. You cant assume the market is a perfect place where you wont have some reversion, said BofA Merrill executive Adam Inzirillo. There will always be some level of it.
Rather, BofA Merrill compares participant quotes against the national best bid and offer both one minute before and one minute after every trade. This way we can see if there is any abnormal spread widening or spread compression taking place, said Oliver Sung, a director on the execution consulting team within global execution services at BofA Merrill.
The idea is that when you place an order, you should see very little deviation in the spreadthe midpoint actuallybefore and after an execution, Sung explained.
Both Merrill and Deutsche Bank use their technology to monitor the activity in their own pools as well as other venues, including exchanges. For Deutsche Bank, the functionality is built into its Super X Plus dark liquidity-seeking algorithm.
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