Buy-side market participants should be aware that not all longer-term trading strategies are benign and that executing against them may be detrimental, according to a new study by Credit Suisse.
The research, titled ‘Classifying dark counterparties’, uses the Swiss bank’s Alpha Scorecard tool, which quantitatively measures dark pool interactions on the firm’s Crossfinder dark pool, to examine the impact of interacting with different types of trading flow.
When the researchers looked for opportunistic trading behaviour, the Alpha Scorecard methodology highlighted some longer-term trading flow for its oversized and overly-aggressive manner. These strategies traded in dark pools on the way to taking out several price levels on displayed order books, causing the stock price to move adversely.
Alpha Scorecard divides counterparties into one of three groups – contributory, neutral or opportunistic – based on whether a counterparty bought at a low price and sold at a high price (contributory) or the reverse (opportunistic). The Credit Suisse methodology analyses trading behaviour visible consistently across a large number of dark fills. When analysing each dark fill, the team used average spread and intraday volatility to create a stock-specific timeframe to ensure the results were accurate and relevant.
Opportunistic counterparties are identified in Crossfinder and are unable to choose their counterparties, whereas those identified as contributory or neutral are allowed to choose – effectively allowing those market participants that are deemed ‘responsible’ to avoid those that are not.
According to the Alpha Scorecard, opportunistic activity can sometimes account for as much as 10% of flow in a dark pool, although it does point out that the figure is normally closer to 5%. The paper also warns that aggregated flow can mask undesired behaviour, making it more difficult to identify opportunistic flow.
Following the introduction of the Alpha Scorecard, Credit Suisse has reported that Crossfinder now accounts for just over 15% of the firm’s European flow in Q2 2012, up from around 8% when the Scorecard was introduced in Q1 2011.
Dark pools that aim to prohibit certain types of trading flow or empower users to choose who they execute against are growing in Europe. CA Cheuvreux recently converted its BLINK broker crossing network into a multilateral trading facility and structure the venue to preclude high-frequency trading, while Quote MTF announced QLX, a hybrid trading venue that allows users to choose the counterparties they interact with. Furthermore, Turquoise and Nasdaq OMX Nordic have adjusted their dark pools to favour trading in larger size.