Electronic and Algorithmic Trading Technology: The Complete Guide

224 Pages·2007·3.16 MB·English

by  Kendall Kim

Advance Praise for Electronic and Algorithmic
Trading Technology
‘‘KendallKim’sElectronicandAlgorithmicTradingTechnologyiswellwrit-
ten,thoroughlyresearched,andlogicallyorganized.Ilookforwardtousing
the bookas aresourcefor class.’’
—Dr. Scott Gibson, Professor of Finance at the William & Mary Mason
School ofBusiness
‘‘In Electronic and Algorithmic Trading Technology, Kendall Kim provides
valuableinsightinto thehighly specialized worldof computer trading. This
includeskeyterminologyanddefinitions,regulatorybackground,andindus-
try drivers. In addition, the book provides an overview of the technologies
andmethodologiesthatcomprisethiscomplexindustry.ElectronicandAlgo-
rithmicTradingTechnologyisroadmaptotheworldofcomputertradingand
isessentialreadingforbothbuy-andsell-sidemarketparticipants.’’
—Sean Gilman,CTO,Currenex
‘‘KendallKimhasmanagedtogiveacomprehensiveoverviewofthemech-
anisms,thecompetitivelandscape,andevensome forecasts onthecomplex
andquicklyevolvingtopicofelectronicandalgorithmictradingtechnology.
DeepdomainknowledgeiscriticaltosuccessonWallStreet;understanding
complex market forces at work only enhances the value one can bring to
their trade. Anyone who wants to learn more about this rapidly evolving
phenomenon can benefitby reading Kendall’s book.’’
—Jeff Hudson, CEO, Vhayu Technologies Corporation
‘‘Comprehensiveandup-to-date.Usefulforbothpractionersandacademics.’’
—GeorgeS. Oldfield,Principal, The BrattleGroup Washington, D.C.
‘‘ElectronicandAlgorithmicTradingTechnology’’isanexcellentresourcefor
bothacademicsandfinancialprofessionalsoutsidethedomainofelectronic
tradingwhoareseekingacomprehensivereviewofanincreasinglycomplex
andever-changingtradinglandscape.KendallKimhasmanagedtoprovide
aninsightful,engaging,andeminentlyaccessiblesummaryofthecoreelem-
entsofalgorithmicandelectronictrading,thechallengesfacedbyalltrading
businesses today, and what lies in store for the future of trading across a
multitude of asset classes.’’
—Manny Santayana, Managing Director Advanced Execution Services –
Equities, Credit Suisse
‘‘Kendall Kim’s work is a thorough snapshot of the world of automated
trading, with an intricate history explaining why and how we got where we
are today. Packed with examples and anecdotes, it makes an impressive
reference guide to the multitudes of algorithms, systems and regulations in
existenceacross theglobe.’’
—Matthew J Smalley, Director – ETD Execution Technology, UBS
Investment Bank
Complete Technology Guides for
Financial Services Series
Series Editors
Ayesha KaljuveeandJu¨rgen Kaljuvee
Series Description
Industry pressures to shorten trading cycles and provide information-
on-demand are forcing firms to re-evaluate and re-engineer all operations.
Shortened trading cycles will put additional emphasis on improving risk
management through front-, middle-, and back-office operations. Both
business and IT managers need to effectively translate these requirements
into systems using thelatesttechnologies and thebestframeworks.
The books in the Complete Technology Guides for Financial Services
Series outline the way to create and judge technology solutions that meet
business requirements through a robust decision-making process. Whether
your focus is technical or operational, internal or external, front, middle,
or back office, or buy vs. build, these books provide the framework for
designing a cutting-edge technology solution tofit your needs.
We welcome proposals for books for the series. Readers interested in
learning more about the series and Elsevier books in finance, including
how to submitproposals forbooks inthe series, can go to:
http://www.books.elsevier.com/finance
Electronic and Algorithmic
Trading Technology
The Complete Guide
Kendall Kim
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Kim,Kendall.
Electronicandalgorithmictradingtechnology:thecompleteguide/KendallKim.—1sted.
p.cm.
Includesbibliographicalreferencesandindex.
ISBN:978-0-12-372491-5(pbk.:alk.paper) 1. Stocks—Prices—Mathematicalmodels.
2. Programstrading(Securities)3. Stockexchanges.I. Title.
HG4636.K552007
332.64—dc22
2007013849
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Special thanksto Sang Lee of theAite Group as well as Larry Tabb and
Marty Rabkin of theTABB Group whose valuablecontributions and
generosity have made this book possible.
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Contents
AbouttheAuthor xiii
Series Preface xv
Introduction xix
CHAPTER 1
Overview ofElectronic and Algorithmic Trading 1
1.1 Overview 1
1.2 The Emergenceof ElectronicTrading Networks 2
1.3 The Participants 4
1.4 The Impact ofDecimalization 6
1.5 The Different Faces ofElectronic Trading 8
1.6 Program Trading and the Stock Market Crash of1987 10
1.7 Conclusion 13
CHAPTER 2
Automating Trade and Order Flow 15
2.1 Introduction 15
vii
viii Contents
2.2 Internal Controls 16
2.3 Trade Cycle 17
2.4 Straight-Through Processing and TradeAutomation 19
2.5 Data Management 20
2.6 Order Management Systems 22
2.7 Order Routing 25
2.8 Liquidity Shift 26
2.9 Conclusion 28
CHAPTER3
The Growth ofProgram and Algorithmic Trading 29
3.1 Introduction 29
3.2 A Sample Program Trade 31
3.3 The Downside of Program Trading 33
3.4 Market Growthand IT Spending 36
3.5 Conclusion 38
CHAPTER4
AlternativeExecutionVenues 39
4.1 Introduction 39
4.2 Structure ofExchanges 40
4.3 Rule 390 43
4.4 Exchanges Scrambleto Consolidate 44
4.5 Arguments Against Exchanges 44
4.6 The Exchangesin theNews 46
4.7 Conclusion 49
CHAPTER5
AlgorithmicStrategies 51
5.1 Introduction 51
Contents ix
5.2 Algorithmic Penetration 52
5.3 Implementation Shortfall Measurement 54
5.4 Volume-Weighted AveragePrice 56
5.5 VWAP Definitions 58
5.6 Time-Weighted Average Price 60
5.7 Conclusion 62
CHAPTER 6
Algorithmic Feasibilityand Limitations 63
6.1 Introduction 63
6.2 Trade Structure 64
6.3 Algorithmic Feasibility 64
6.4 Algorithmic TradingChecklist 66
6.5 High Opportunity Cost 67
6.6 NewsflowAlgorithms 68
6.7 Black Box Tradingfor Fixed-Income Instruments 69
6.8 Conclusion 70
CHAPTER 7
Electronic Trading Networks 71
7.1 Introduction 71
7.2 Direct Market Access 71
7.3 ElectronicCommunication Networks 75
7.4 Shifting Trends 79
7.5 Conclusion 80
CHAPTER 8
Effective Data Management 83
8.1 Introduction 83