US buy-side traders continue to increase their reliance on algorithmic trading at the expense of sales traders despite higher volatility in recent months.
Research from US consultancy TABB Group titled ”US equity trading: low touch trends', predicts the use of algorithms in the US will rise by 21% this year, to account for 35% of buy-side order flow in 2011, compared to 29% in 2010.
Cheyenne Morgan, research analyst and co-author of the report, believes the ongoing rise in algo usage is a result of greater confidence in their performance during the unprecedented volatility at the end of 2008 and start of 2009.
At the end of 2008 the VIX, an index measuring volatility based on the S&P 500 index, swung between 50 and 80 as events such as the collapse of US investment bank Lehman Brothers shook market confidence.
Volatility has since reduced to between 25 and 30 in recent weeks, although events including the sovereign debt crisis pushed the VIX back up to 40 in May, the highest it has been for a year.
“During volatility, traders need guidance on the market from sales traders, but still had to use algorithms for a portion of their flows,” Morgan told theTRADEnews.com. “Traders were able to master their use of algorithms during this time and as market conditions have become more stable, overall reliance on sales traders has decreased.”
Morgan adds that increased use of algorithms remains an ongoing trend despite this volatility and further shaking of market confidence resulting from the 6 May flash crash, which saw sharp and drastic declines in US stock and exchange-traded fund values.
According to another TABB study published shortly after 6 May, 20% of buy-side traders interviewed considered execution algorithms to be the primary cause of the crash.
“The events of 6 May seem only to have been a blip in the eyes of most buy-side traders,” said Morgan. “While 20% blamed execution algos, 37% held high-frequency traders responsible and 35% blamed the Reg NMS route out rule, which indicates the continuing uncertainty over the primary cause of the crash.”
The behaviour of buy-side traders in the US comes in contrast to that in tweak and customise tools in accordance with their trading strategies.
“Customisation will become a value-added service that will determine the next generation of algo trading and help brokers earn more commission dollars from electronic execution services,” said Morgan.
TABB's study is based on interviews with 123 head traders of US-based institutional equity management firms and hedge funds.