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The Buy Side Takes Charge

Access to aggregators, crossing networks and algorithms is changing the buy-side trading desk.

It's no secret that buy-side traders are taking more control over their order flow. But what is surprising is the degree to which buy-side traders at large, small and medium-size firms are using a variety of tools - including aggregators, crossing networks and algorithmic-trading strategy servers - to time their orders in the market and capture liquidity wherever it exists.

"We utilize the ECN [electronic communication network] aggregators - REDIPlus, B-Trade and Direct Trade," says Matt Miller, head trader at BPI Global Asset Management, based in Orlando, Florida, which has more than $5 billion in assets under management. On those platforms, "You can send orders directly to the American Stock Exchange, or [you can send] DOT [Designated Order Turnaround] orders to the New York Stock Exchange, or use it simply as an ECN sweeping an internal or external book," Miller says.

As buy-side institutions shift more of their order flow to automated execution venues, they can, in theory, focus more time on the value-added trades, such as small- and mid-cap stocks that are less liquid. But are they trading cheaper, faster and better? And, while firms appear to have a plethora of tools at their disposal from brokers and financial technology vendors, are there gaps in the arsenal?

The More, the Merrier

Larger investment management firms, like Barclays Global Investors (BGI), headquartered in San Francisco, with $1.14 trillion in assets, want to connect to as many liquidity sources as possible. "We construct a system that has access to all points of liquidity," says Richard Tsai, BGI's head of electronic trading. Tsai says BGI doesn't want to be limited to one broker or exchange floor. "The nature of liquidity changes all the time," he says. "If I have Broker X, plus ECNs, plus crossing networks all hooked up to my system, then I have more venues to trade with," he explains.

But, why are buy-side firms using multiple electronic-trading strategies, and how is the evolving trend going to impact the buy-side trading desk?

According to a recent report by The Tabb Group, "Institutional Trading in America: A Buy-Side Perspective," electronic trading is taking off on the buy side because of radical changes in market structure caused by the conversion from fractions to decimal pricing. Decimalization, together with the impact of ECNs and algorithmic trading, has reduced the average number of shares per trade from 1,400 six years ago, to 500 shares today, the study says. Because decimalization has increased the number of incremental price points from 16 to 100, it has fractionalized liquidity that was once centralized on each 6.25-cent increment, according to the report. Hence, buy-side traders are using many different strategies to work their orders, rather than relying on just one technique.

"More and more buy-side traders are using advanced technology to trade, both from the standpoint of being able to take advantage of lower commission rates, as well as to reduce their market impact," says Larry Tabb, founder and chief executive officer of The Tabb Group, who authored the report. If buy-side firms can use tools like algorithmic trading to break up orders into smaller pieces and execute them over time, the trades have less impact on the market than if they show there's 100,000 shares for sale, Tabb explains. He adds that algorithmic trading is catching on because the buy side can get an algorithm that's designed to match a benchmark, such as average price or volume weighted average price [VWAP], or they can participate in volume that is ticking up or try to measure implementation shortfall by maximizing the amount of shares they execute at the arrival price to avoid a movement in price.

Ivy is Editor-at-Large for Advanced Trading and Wall Street & Technology. Ivy is responsible for writing in-depth feature articles, daily blogs and news articles with a focus on automated trading in the capital markets. As an industry expert, Ivy has reported on a myriad ... View Full Bio

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