PURE ALGORITHMIC TRADING SOLUTIONS WHEN TACTICS OVERWHELM STRATEGY Technology and sophisticated trading tools help traders find the best trading venues. In a fragmented environment, however, traders risk being consumed with tactical decision-making at the expense of strategic decision-making. Specifically, while being inundated with an ever-growing amount of trade and market information, traders find themselves with less time to get a "feel" for the market to harness their skills to determine how the market is performing and what underlying trends are most important. Taking Charge Institutional traders are increasingly looking to address this imbalance by automating the fill-by-fill "chiseling." A strong competitive alternative would allow traders to define algorithms that automate global order execution from simple execution rules for small orders to sophisticated strategies for large orders while incorporating technical indicators and maintaining cash-balancing. Employing algorithmic solutions can significantly increase trading efficiency, empowering traders to act as a stronger strategic partner to portfolio managers. Instinet Pure Algorithmic Trading puts the trader back in the role of managing trading strategy. Our algorithmic products empower clients to use a particular rule when it makes the most sense, and they do so without worrying about information leakage. Instinet's rules take advantage of a wide variety of liquidity pools including certain securities crossing networks, ECNs and exchanges. it's very difficult to get any sort of "feel" from an endless stream of small executions. That feel is what we've all been hired to discern, and it's what we each add to our respective investment processes. Without it, we re just pushing paper." "RAGE AGAINST THE MACHINE," TRADERS MAGAZINE, JULY 2004.
Who s Looking at My Trade Information? Buy-side firms are rightly looking for algorithmic products that promise the best of both worlds: advanced technology and no information leakage. In other words, algorithmic products that allow them to execute their block trades with minimal market impact. Institutional customers are learning that while having a sophisticated rule is important, keeping that rule under tight wraps is even more critical. While traditional brokerages with proprietary trading operations may never data mine the customer s unexecuted order information, a firm can make logical inferences based on its unique knowledge of the rule it has written, and can adjust its proprietary trading strategy based on this unique information. How does this happen? Algorithms are automated trading behavior created by your broker. Logically, a broker could make inferences or predictions about your future trading activity based on the broker s knowledge of the algorithm created either by working off of publicly executed trading information or pre-trade information. As a result, these broker-as-principal trades in many cases cause market impact, increasing a customer s implicit trading costs. In sum, the first question you should ask your broker if you are using algorithmic trading is: "What happens to my trading information?" EVEN POST-TRADE DATA MINING CAN HURT YOU Traditional brokers with proprietary trading arms can use your post-trade information to make inferences about your future trading activity. It is only 42 min into the trading day now, so the majority of the volume under the rule still remains to be executed. Time Rule 10:12am VWAP The trade uses a VWAP rule, so it will be executed throughout the trading day using the VWAP "smile" curve. Stock XYZ Aggregate buy shares executed (% market volume) 50,000 (25%) Aggregate sell shares executed (% market volume) 20,000 (10%) The rule executes buys and sells on the same schedule. Until, now the rule has executed a "net buy" of 30,000. The broker's proprietary trader concludes that in the aggregate all customers orders represent a "net buy" position for the remainder of the day. The day s volume in XYZ has been 200,000 shares in the market until now. So far the rule executed a "net buy" on 15% of the market volume (25% - 10% = 15%). Therefore, the trader concludes that the "net buy" position presents 15% of the remaining day s volume and will likely be driving the VWAP higher.
Working with You for All These Years Instinet s Pure Algorithmic Trading Solutions put the trader back in the role of managing trading strategy. We have been offering algorithmic trading solutions for approximately 15 years. Thus, our brand, experience and agency-only business model position us well in this growing segment of the market. Instinet s Pure Algorithmic Trading Solutions empower our clients to use a particular rule when it makes the most sense, and they do so without worrying about information leakage. Instinet's experienced in-house traders work with our clients to create custom rules that adapt to individual trading strategies, taking advantage of a wide variety of liquidity pools including certain securities crossing networks, ECNs and exchanges. Our off-the-shelf rules, developed for the most common trading strategies, include: Global VWAP Targets either full-day or interval VWAP in any market. The Global VWAP rule handles portfolios and single orders, and supports buy, sell and short-sale orders. Careful Discretion The Careful Discretion rule is configured to beat the mid-spread price at the time the order was received. As such it can be used to minimize implementation shortfall, or even add value to the portfolio by beating the arrival price. "Building an algorithm is not an easy task," according to the Tabb Group. "To prevent pattern recognition and manipulation, the algorithms are tremendously complex. If a simple VWAP engine goes into the market every 30 seconds and buys 300 shares of Intel at the market, very soon someone will realize this pattern and bid the stock up at 28 seconds (before the electronic trade) and sell the position back to the market at 31 seconds, at a higher price," the Tabb Group adds. THE AGE OF THE ALGORITHM, TRADERS MAGAZINE, SEPTEMBER 1, 2004. Trade Rate The trade rate rule is appropriate for cases where trading in line with the market s volume is desired. Unlike the VWAP/TWAP rule, which will slow down or accelerate the execution of an order based on a predefined schedule, Trade Rate dynamically adapts to volume conditions throughout the day. Contingent Pairs This algorithm has been designed to automate relative value pairs trading strategies. It can be used for single pairs or for relative-value baskets. BlockPeg SM Aims to achieve price improvement for blocks of both exchange-listed and OTC stocks by allowing simultaneous representation of portions of a limit order in multiple liquidity pools. The rule manages order exposure across multiple venues to conceal order characteristics and maximize fill rate. In addition, this rule makes pegging, reserve size and discretionary limit price functionality available for trading NYSElisted stocks for the first time. 15
WHY UNCONFLICTED MATTERS WITH ALGORITHMIC TRADING As with all Instinet solutions, our Pure Algorithmic Trading Solutions are founded on the principle that we offer an unconflicted model, technology, and culture. At the heart of the Instinet s algorithmic model is the guarantee that no one at Instinet has the means or motive to capitalize on your trading information to benefit any proprietary trading interest. Quite simply, Instinet does not have related businesses that would tempt us to leverage your trade information for our benefit. Instinet has built its rules technology with one purpose: to provide the most sophisticated rules to customers so they can take advantage of either off-theshelf rules or customized rules and keep their focus on strategic decision-making. These Instinet products and services are designed for institutional customers who face the question every day: "Is my broker competing against me or serving me?" While they may sometimes have to accept compromises when working with other brokers, they won t with Instinet. We are committed to delivering pure low-cost solutions. 16
To learn more about how Instinet helps clients deliver Pure Solutions every day, contact your local sales representative or visit us online at www.instinet.com. 2004 Instinet, LLC and its affiliated companies. All rights reserved. INSTINET is a registered mark in the United States and other countries throughout the world. Instinet Research Partners is a product group of Instinet, LLC. Instinet, LLC, member NASD/SIPC, branded as Instinet, The Unconflicted Institutional Broker, is a subsidiary of Instinet Group Incorporated which is part of the Reuters family of companies. Instinet (including its affiliated companies) does not operate, control or maintain any ownership interest in Cross Industrial Research, Datamonitor, Ross Smith Energy Group, or Retail Intelligence Group. Instinet Group Incorporated has a 2.14% voting interest in Archipelago Holdings, Inc. *The term "partner" strictly relates to the services provided by Instinet and is not to be interpreted as creating a general or limited partnership or any other legal relationship with Instinet, LLC. **Patent-pending. PS 1204