Program traders are now techies. That's regardless of whether they under stand it or not. Robert Hegarty, head of TowerGroup's securities and investment practice, says program trading is increasingly accepted because of technological advancements.
"There is a growing number of tasks that buyside traders routinely perform to make buy and sell decisions that rely 100 percent on computer programs," he said.
Even portfolio managers are running portfolios through models to determine what they should buy and sell.
"Everyone knows that the concept of technology is simple," said Manny Santayana, a trading pro at Credit Suisse First Boston in New York who specializes in program trading. "It's all about moving the power of trading upstream into the hands of end-users hands."
Electronic trading has revolutionized the entire culture of CSFB, and Morgan Stanley as well. "The smart brokers are giving tools to the buyside customers so that we can give them commission reductions," Santayana said. "If you give the power of the trade to the end user so they can do trades themselves, you can actually make more money."
Many dealers now believe that buyside traders – especially program trading oriented buysiders – come out on top when they take more control of the trade with electronic tools. Volume from value-added services – like security analysis, market read or capitalization trading – should not be impaired at all by electronic cash or program trading order flow, trading experts say.
"My buyside customers are telling me that both CSFB and Morgan Stanley are at the forefront of service delivery to buyside program traders," said Mark Enriquez, chairman of Pulse Trading, Inc., an institutional electronic agency broker in Boston, Massachusetts. CSFB is giving traditional buyside traders and program traders tools in a package that combines algorithms for order management with smart order routing. Morgan Stanley has a similar package.
Two of the most talked about elements for successful buyside trading are liquidity and anonymity. But there are other critical elements. "They are productivity, reliability, versatility, quality results, and ease-of-use," said Santayana.
At the same time, the recent bear market has caused portfolio managers to look more carefully at trading performance numbers.
Still, there is some confusion among pros. "A lot of people confuse program trading with basket trading," said Hegarty of TowerGroup, which is based in Needham, Mass.
Program trading is executing set trades that will accomplish a specific objective, often called a "program." Computers are often used because the algorithms – that define the "programs" – are obviously complex. This approach usually speeds up executions. Fair value arbitrage of the S&P500 futures, versus an S&P500 cash index replication using some 10 percent of the underlying stock, is a relatively simple example.
This is classical arbitrage – the simultaneous buying and selling of the same goods in different markets at the same time for profit. "The program trading that buyside traders use might better be called basket trading," Hegarty said.
Thus, when traders and brokers talk about program trading, they usually mean basket trading. Despite this interpretation, program trading is often used synonymously with basket trading, or trading with almost any computer based-based trading. And that includes order gathering or execution.
"Only about four percent of our trades are program trades even though I hear that program trading is now 30 percent to 40 percent of NYSE volume," said William Stephenson, IV who is director of trading for Franklin Templeton Investments in Fort Lauderdale, Florida.
Why so few? "We do use baskets sometimes, but our order flow usually doesn't really fit basket trading very well," he said.
Program commission rates can often be lower than straight trading rates. Franklin Templeton pays six basis points for global program trading. Said Stephenson: "This means lot of people are using program trading to get lower commission rates and not because it makes operational sense for them from a market impact standpoint."
Decimalization has produced one unintended consequence. Increased liquidity hasn't happened. "A lot of the big guys on Wall Street are telling me this," Santayana said.
The orders are there, but while people once might have opportunistically made a teeny' trading, they can now only make a penny. So now, they don't want to show what they have to do.
"A few of the big mutual funds here in Boston are committing a growing percentage of their trades to baskets," Pulse's Enriquez said. "They seem to think baskets can lessen individual opportunity risks, by putting some less liquid stocks that don't lend themselves well to electronic trading in each basket to proprietary trading shops."
A financial basket might comprise stocks like Citibank, J.P. Morgan Chase, Bank One Corp, Prudential and Merrill Lynch.
The first step in setting up a basket is to apply an automated algorithm to determine its value down to a penny a share to see what its effect on the portfolio might be. One also wants to measure how efficiently it can be traded. Much of this is now automated, using a system designed by firms such as BARRA. Enriquez says funds will pay more for manual brokering of illiquid securities, sometimes on an agency basis to make up for the higher commission costs.
"Good traders can usually tell when a mechanical trading program is underway. They see somebody who mechanically joins the bid to shrink the spread. They then put in their orders of a penny above the bid and then start hitting bids," Enriquez said.
"Reasonably smart traders will defeat automated programs by either avoiding the market or jumping ahead of automated programs," he added.
Enriquez doesn't think there's been much of a change in technology itself. However, he argues that the existing technology applications have improved the execution process overall.
Logical Step
Another example of combining applications, is a coming venture between Macgregor and Lava Trading. The two are planning to integrate electronic trading with Macgregor's blotter, according to trading sources.
While this venue will accommodate only the straight buying and selling of stocks one-by-one electronically now, a basket trading function should be the next logical step.
Some buyside traders, meanwhile, are using outside services, such as H.L. Camp & Company Program Trading Research in Palm Beach, Florida, for statistical data in program trading.
"It all has to do with the fast-growing acceptance of program trading relying almost 100 percent on computer programs to make the buy and sell decisions," TowerGroup's Hegarty said.
