Chapter 5 - Algorithmic Strategies

Abstract

This chapter focuses on the various algorithmic strategies employed by the brokerage firms. Having more algorithms at the trader's disposal provides both opportunities and challenges. On the upside, a trader now has the opportunity to pick the suitable algorithm that may most likely achieve the trading objective for each order. On the down side, the number of algorithm choices can be so large as to make it difficult to make a quick and correct choice. The utilization of algorithmic trading has advanced as participants strive for better execution prices for their investment objectives. Volume-Weighted Average Price (VWAP), Time-Weighted Average Price (TWAP), implementation shortfall, and arrival price represent the basic algorithms provided by a brokerage firm. VWAP remains the primary benchmark for algorithmic trading. Daily VWAP can be calculated through the record of daily stock transactions. Some brokers have made substantial investments in sophisticated algorithms, while for other brokers, algorithms are simply another method of generating business despite being a loss leader simply to help the firm's bottom line. Bulge-bracket firms are most likely to develop their algorithms in-house, investing significant amounts in constantly refining their offerings. They will also use statistics and trade data based on internal algorithmic flows to determine transaction costs and market impact costs. Smaller niche brokers may go with vendor solutions that charge a flat fee. Agency brokers have an advantage in providing nonproprietary services that service the customer alone. A bulge-bracket firm may also utilize client flow to analyze the data for their own proprietary trading desk.