U.S. Algorithm Spending Slows

Algo spending hits a plateau in the U.S., but more-sophisticated offerings are on the horizon.

After growing at substantial rates over the last several years, spending on algorithmic applications by the buy side is slowing in the United States. According to research by Datamonitor, buy-side spending in the U.S. on algorithmic trading applications will rise slightly from $442 million in 2007 to $454 million in 2008 and $469 million in 2009.

While large investment management firms and hedge funds will continue to spend on algorithms, experts predict their spending will slow. And many buy-side traders at smaller shops remain skeptical about depending on algorithms to trade large amounts of their orders, particularly if they are focused on smaller-cap names.

But as we move into 2008, many algorithm providers are hoping to spur renewed interest with new and different offerings. The slowed investment here in the U.S. leaves the door open to increasing growth overseas and a new crop of algorithms that might just boost spending on automated trading strategies beyond its current plateau. Next up in the algo space -- better dark pool access, more-adaptive strategies, portfolio-based strategies and algorithms that go beyond equities into new asset classes.

Though Michael Crockett, senior equity trader at Dallas-based Brazos Capital Management, trades mainly smaller-cap stocks for which he doesn't generally use algorithms, he says the older generation of algorithms is past its prime. Emerging algorithms, Crockett suggests, will be more sophisticated and adaptive. "If someone is still using VWAP or participation algorithms, there is no way they are getting best execution," he contends.

Reflecting an attitude that likely has contributed to the algo-spending slowdown, however, Crockett notes that he is hesitant to use algorithms to a large degree because he depends on his sell-side relationship. "When I put an order in an algorithm I don't know who the other side is; I don't know how much information I am giving away or how much that could cost me," he explains. "I depend on solid, ethical relationships I can trade on."

Still, Crockett adds that he does "look at every algorithm and every technology I can get my hands on." Unfortunately, he says, there are only a few firms that understand where the market is going and have enhanced their algorithms to reflect the new market dynamics.