Agency broker Knight Capital's liquidity-seeking algorithm has been dramatically overhauled to account for an evolving market structure characterised by growing levels of high-frequency trading (HFT).
Knight Capital MD Joe Wald said the broker has “radically redesigned” Sumo, one of the first algorithms designed to use real-time and historical liquidity measures to complete an order as quickly as possible – to account for the increasing use of HFT strategies and their impact on liquidity.
“Sumo’s objective is still the same. Institutions can block trade while avoiding short-term alpha strategies which can have a negative impact on execution quality. But now it’s not about being liquidity seeking. It’s about size discovery,” said Wald.
With predatory strategies now so advanced they can anticipate traditional smart order routers using price discovery, Sumo’s size discovery methodology seeks the largest order at each venue to complete as much of the trade as possible before other market participants can benefit from the information.
Wald said another new feature of Sumo’s underlying strategy was signal-based trading. The algo collects data on size and quote from the lit markets and through Knight’s Order Awareness technology, it gains feedback from recently completed executions at Knight to determine the best liquidity venue or venues, appropriate order size and timing. Concurrently, Sumo emanates liquidity-seeking signals which don’t look like typical existing participation strategies, helping protect client orders from aggressive short-term traders.
“There is a huge amount of HFT out there but within that liquidity there are different types of flow and not all of it is bad,” said Wald. “You need to decipher what is the more benign and what is the more aggressive.”
Sumo aims to distinguish between passive or neutral electronic traders. Wald said some high-frequency strategies can glean more and more information from the slice and spray approach of many buy-side algos, making ‘cost-biased’ smart order routers less effective over time.
“Sumo counters with a ‘size-biased’ routing strategy to find larger blocks of liquidity at fewer venues, moving orders through the marketplace in such a way as to reduce information leakage,” said Wald.
American, British and European buy-siders can access Sumo and Knight’s other algos through Knight Direct’s broker-neutral electronic trading platform and through order and execution management system providers.