Pragma Rolls Out New Router that Considers Shortfall Costs
Traders Magazine Online News, March 28, 2012
Pragma Securities on Wednesday unveiled a new routing methodology that considers implicit shortfall costs—as well as the explicit costs associated with a venue—when it decides where to send a trade.
David Mechner, chief executive officer of Pragma, said the firm hasn’t come up with an official name for the methodology, but has been referring to it internally as the RSOR—the Really Smart Order Router.
David Mechner
The new methodology differs from traditional smart order routers by looking at the total cost of a trade. While most SORs consider the explicit cost of a venue, they do not weigh the implicit costs of having an order fall at the end of a queue, which could hurt performance if prices move against the trader.
“There’s this direct tradeoff between implicit costs, in terms of shortfall, which are realized by the client, and explicit costs, in terms of fees and rebates, which are realized by the broker,” Mechner said.
Most SORs route first to the venue with the biggest rebate or the lowest fee. Sometimes, though, it might make more sense for a trader to pay a bit more in order to get to the front of the line. The trader can do that by having an order filled quickly at an inverted venue.
Inverted exchanges, such as EDGA, Nasdaq BX and BATS Y, pay rebates for taking liquidity. By posting passive orders on inverted venues, traders forego the explicit rebates offered by exchanges with traditional pricing models, which pay traders for making liquidity. However, passive orders on inverted venues get filled faster than on traditional exchanges.
The new methodology looks at a number of factors that indicate it might be cheaper for a client to hop the queue, paying a bit extra at an inverted venue. Those factors include volatility, stock price and depth of book.
Mechner said buyside traders generally understand that shortfall can have an effect on execution quality, but it can be more important to some strategies than others. He said systematic traders trading large baskets of stock on a daily basis will benefit the most from the new methodology.
The new SOR has been incorporated into the majority of Pragma’s algorithms, though Mechner said it didn’t make sense for some algos, such as aggressive liquidity seekers.
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