IS 356 IT for Financial Services Algorithmic Trading Portions of this presentation are compiled from presentations given by Morgan Stanley entitled “Algorithmic Trading: Equity Trading vs. Futures Trading” and others by the Tabb Group.

October 8, 2015 Why should you care?  Algorithms are dominating the market – They are the future of securities trading  If you want to work for a buy-side firm… – Expect to find algorithms in your toolbox – Have you heard about quant funds?  Not all algorithms are the same – Some are little better than a coin-toss – Others will rock your socks off  Got math and statistics? © Paul Tallon 2/21

October 8, 2015 TED – Ideas Worth Spreading © Paul Tallon 3/21

October 8, 2015 Information Processing Time Falls © Paul Tallon 4/21

October 8, 2015 Job Postings © Paul Tallon 5/21

October 8, 2015 What is an algorithm?  A pre-defined step-by-step method to accomplish a task  A computer model that takes an order and structures a sequence of trades that aim to achieve the stated objectives… – Minimize cost compared to a defined benchmark – Maximizing fill rate – Minimizing execution risk 6/21 Source: Morgan Stanley

October 8, 2015 Is the current trading model broken? © Paul Tallon 7/21

October 8, 2015 Why use algorithms? © Paul Tallon 8/21

October 8, 2015 Types of algorithms… © Paul Tallon 9/21 Source: Tabb Group

October 8, 2015 Algorithm selection criteria © Paul Tallon 10/21 cost

October 8, 2015 Algorithm Challenges  Not great with illiquid stocks – If volume is low on a typical day, there’s not much point in adopting an algorithm  Algorithms do not react well to news releases – Humans are still needed to interpret releases  Commoditization is a reality – Seen one, seen ‘em all (not quite yet)  The return of volatility calls for quality algos © Paul Tallon 11/21 Source: Adam Sussman, Tabb Group

October 8, Trade lifecycle Control Feedback Loop Benchmark Determination Execution Sort Limit Order Prog. Crossing vs. Liquidity Pool Trade/Trajectory Planning Execution Evaluation TCA Source: Morgan Stanley 12/21

October 8, Benchmark Determination More StructuredLess Structured Order(s) Trade Structure Development Schedule BasedFlexibleDynamic  VWAP  TWAP  Volume Participation  Arrival Price  Price React Source: Morgan Stanley 13/21

October 8, Trade/Trajectory Planning  The VWAP strategy creates a trade plan that emulates the historic volume distribution (either all day or interval).  Trajectories are static from the beginning of the trade and do not respond to changes in intraday liquidity. 3. Volume % Limits 1. Price Limits 2. Duration Limits Parameters Available for VWAP are: Source: Morgan Stanley Volume Weighted Average Price 14/21

October 8,  Order quantities are determined for individual time sub intervals and scheduled for execution according to continuously updated forecasts of volume 1. Price Limits 2. Duration Limits Parameters Available for TPOV Orders: Target Percent of Volume Trade/Trajectory Planning Source: Morgan Stanley 15/21

October 8,  The trader decides a level of execution urgency- get done, high, medium, or low.  Trajectory is based on continuously updated forecasts of volatility, liquidity and spread, and changes dynamically during execution with the changing market conditions.  Order quantities are determined for individual time sub intervals and scheduled for execution. Parameters Available for Arrival Price Orders: 1. Urgency Level 2. Price Limits 3. Duration Limits 4. Volume % Limits Arrival Price: Low Urgency Arrival Price: High Urgency Trade/Trajectory Planning Source: Morgan Stanley 16/21

October 8, 2015 Fidelity Cross Stream LEH LCX CS Cross Finder GS Sigma X UBS PINS Morgan Stanley POOL CITI ACE MS Trajectory Crossing Liquidnet NYFIX Millennium BIDS ITG Now ITG Block Alert Instinet (CBX, etc.) NASDAQ Crossing Network Matchpoint ISE Midpoint Match LeveL Pipeline POSIT TRAC / DATA EDGX / EDGA ONTD BATS BTRD CBOE ISE Stock Exchange NSX / CINN BeX CHX NYSE Arca NASDAQ INET NYSE AMEX PHLX SMART ORDER ROUTING TECHNOLOGY SORT Source: Morgan Stanley 17/21

October 8, Post Trade Analysis 18/21

October 8, 2015© Paul Tallon 19 /21 Insights…

October 8, 2015 For more information… © Paul Tallon 20/21

October 8, 2015© Paul Tallon 21 /20 For Next Class…  Read – The second blog is due on October 9 – First case write-up is due at the start of class on October 2 – Midterm on October 16