Cover Story: Keeping Watch
Traders Magazine Online News, May 7, 2012
For instance, a trader that only takes liquidity may or may not be considered predatory. If he consistently makes money on every trade, or has a positive short-term alpha, then some might consider him a dangerous trading partner. But if he generally loses money on every trade – in other words he is trading even though the market is moving against him – he may be a desirable counterparty.
Likewise a trader with a low modified taker ratio may appear to be a friendly supplier of liquidity. But if prices in the market consistently go his way after his trades, he might appear to be too “informed” for some counterparties.
Jose Marques, Deutsche Bank
For Barclays, the end result is a scatter graph that divides the players into four quadrants: the toxic, the benign, and those in between. ING’s Cacciatore, for one, says the breakdown is useful.
“It gives me flexibility and some control over who I’m transacting with,” he said. “If I don’t want to trade in a particular quadrant, I don’t have to.”
While Morgan Stanley and Barclays wield a big stick when policing their pools, Deutsche Bank takes a more live-and-let-live approach. The broker does not threaten its HFTs with expulsion. Rather it counsels its buyside customers to allow its algorithm to decide when to trade and when not to trade with a potentially dangerous counterparty.
Marques maintains it’s a mistake to unilaterally block out trading with any single player or venue. In the past, clients that have done so, have found themselves cut off from very significant amounts of liquidity.
“There’s a time when it’s perfectly fine to trade with someone you might consider a toxic counterparty,” Marques said. “And that’s when you have an informational advantage. And, of course, there are other times when you definitely want to stay away.”
In general, Marques explains, it’s best to trade very stealthily when starting out with a fresh order, avoiding HFTs. But after completing about 60 percent or 70 percent of the trade, a trader can use his informational advantage and take liquidity aggressively.
“The dark pool ranking model is telling us which sources are benign across volatility and capitalization bins, both internally and externally,” Marques said. “So in the beginning, a participant will trade conservatively, and won’t leak information into the marketplace. But, as the trade evolves, the tactics might change to more aggressively seek liquidity from a broader cross section of sources. This is what good traders have historically done.”
The difference now, Marques added, is that Super-X Plus can do what a person cannot, that is manage this process dynamically across fifty plus venues.
So what do the market makers think of all this? At least one HFT executive is enthusiastic.
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