Once an algorithm has reached its profitability potential in U.S. equities markets, its owner can create another successful algorithm.
Or port that algorithm to a new market.
If you’re looking for a port of call, it is likely to be Canada.
Canada’s markets are more similar to those in the United States than any other country’s in the world. The two countries’ stock indices are similar. The two countries’ markets display the same volatility. The markets share overlapping high-quality listings. And, the two countries’ currencies, both called dollars, run together.
Of course, Canada’s markets have some structural differences. Brokers are part of the trade-matching algorithm: Orders are matched first by price, then by broker, then by time. This is in contrast to U.S. markets, where the orders are matched by price and time. Also, Canada’s dark pools operate under different rules. Nevertheless, Canada is a great option when it comes to porting algorithms. Here are details on the similarities and differences between the markets.
Reason 1: Additional Volume
On an average day, 650 million shares change hands each day on Canada’s equity markets, the Toronto Stock Exchange and the Toronto Venture Exchange. Around 190 of the TSX symbols are inter-listed on the New York Stock Exchange and the Nasdaq Stock Market, accounting for roughly one-fourth of all trading each day.
See Chart: Canadian Equity Volume
In May 2012, a total of 10 billion inter-listed shares traded in the U.S. and Canada. Of these, 6.2 billion shares changed hands in the U.S., while 3.8 billion shares traded in Canada. That means brokers with U.S. clients trading regularly in these names have the potential to pick up an additional 61 percent of volume by crossing the border.
However, the volume distribution of inter-listed stocks differs across sectors. For example, inter-listed financials and inter-listed telecom services execute respectively 75 percent and 84 percent of their volume in Canada. By contrast, inter-listed materials and information technology trade more heavily in the U.S., executing respectively 60 percent and 70 percent of their volume in the U.S. Trading in oil and gas shares is about the same.
About 80 percent of the trading in Canada’s Manulife Financial Corp. occurs north of the border. But 80 percent of trading in Research in Motion, which makes BlackBerry devices, occurs in the United States.
Reason 2: Canadian Markets Behave Like the U.S.’s
The primary United States and Canadian equity indices move largely in parallel.
However, in March, Standard & Poor’s TSX index was flat, while the S&P 500 in the U.S. and the Dow Jones Industrial Average climbed. In June, U.S. indices again climbed while Canadian indices were flat.
Both Canadian and U.S. equity markets exhibit similar volatility characteristics, as illustrated by movement of the S&P 500 VIX and the S&P/TSX 60 VIX. Although the volatility may increase and fall almost in parallel, the magnitude of these daily moves is lower in Canada.
Reason 3: Limited Exchange-Rate Risk
Trade settlement will typically be in U.S. dollars for U.S. investors. So clients need to consider the added risk of converting back to U.S. dollars when trading abroad. Some currencies have large spreads between the bid and ask prices. Some move in great swings against each other. Not so in matchups between the U.S. and Canadian dollars: The spread is generally $0.0002. So a trade of 500 shares at $15 a share will only cost $1.50 in the conversion from one currency to the other.
Volatility in the exchange rate between U.S. and Canadian dollars is also low. In the eight weeks that began July 3, movement in rate averaged $0.0064. That is about half the rate of the daily change between the British pound and the U.S. dollar or the euro and the U.S. dollar.
See Chart: Canadian Volatility
Calling for a Canadian Port
Nuances of Canadian market structure will affect which broker should be employed when crossing the border.
* Size matters
Several Canadian venues match orders on a price-time priority; however, these venues execute only 15 percent of total market volume.
The bulk (85 percent) of the trading occurs on venues that obey price-broker-time priority. Priority is given to a broker based on access to its own order flow, allowing for on-book internalization.
Because of the priority given to the broker involved in a trade, clients should look to partner with brokers that execute a significant share of the market volume.
A broker with a larger market share of volume can provide more queue-jumping opportunities due to this price-broker-time matching methodology. By supplying a greater number of incoming orders to interact with, clients can potentially improve their fill rates and the amount of the spread they capture.
These clients will also take advantage of the anonymity inherent in the large and diverse order flows as a client’s orders will be masked in the broker’s overall flow.
Additionally, brokers with a large market share can reduce a client’s execution costs by getting volume discounts from venues.
* Technological Innovation matters
A broker’s execution platform is key. Clients should consider the speed of brokers’ routing engine and flexibility in routing strategies. Co-location, speed and high throughput are all factors that give clients a leg up in reaching matching orders as they arrive. Flexibility in customizing routing strategies also is a benefit.
Clients also need to consider the cost of their access to the markets. It can be a big effort for a trader looking to port his algorithm to deploy low-latency technology in any new location, including Canada. Trading firms need to purchase hardware and software, data center space, network circuits and local support. Some of these commitments are multi-year contracts. Putting all the technology in place costs roughly $1 million over two years. That excludes the man power that will be needed. Trading firms may also need to become exchange members with financial and regulatory obligations.
However, there are several ways to dip a toe into Canada.
First, you can remotely receive market data and send trades to a Canadian broker from the U.S. Fast routes are available via electronic trading networks.
Second, if you wish to co-locate, you can purchase the use of a high-performance computer, market feeds and order routing from service providers, with as little as a one-year commitment. Since the network, computing and market data services use the same technology many firms use in the U.S., there is minimal drain on your staff.
Then, you’re ready to call on markets in the True North Strong and Free as the next port for your algo.
Heather Killian is an executive director for electronic trading and product development for CIBC World Markets. Arthur Milner is an associate for electronic trading and product development for CIBC World Markets. Jeff Drew is the Liquidity Center Program director for NYSE Technologies.
