Algorithm developers and user should start planning now how the new London Stock Exchange (LSE) midday auction, due to launch later this year, will impact their trading strategy and performance, according to a whitepaper.
The paper, Intraday auction – Are your algorithms ready for them, was published by agency broker Neonet Securities and transaction cost analysis specialist LiquidMetrix, and outlines some of the key issues algorithms will need to grapple with when the UK intraday auction goes live.
“The main technical challenges for agency trading algorithms will be to decide how much to post into London Stock Exchange’s auction and what, if anything, participants should do in terms of post trade analysis to ensure that the auctions they are participating in are not being ‘gamed’ by other participants,” the report said.
For participation-style algorithms, algorithms will need an estimate of the total uncrossing volume the auction will generate each day, taking into account factors such as historical stock data, how trading progresses and, once trading has begun, the algos will need to continuously update their estimate of the uncrossing volume based on LSE published data.
For more opportunistic-style algorithms, the report’s authors, Dr Darren Toulson of LiquidMetrix and Jan Jonsson of Neonet, said getting as much volume done as possible during the auctions is likely the best strategy. However, this creates a larger opportunity to be gamed and risk not achieving the best price, either due to outside influence or unintended distortion by an investor’s own orders.
The paper advises monitoring how orders affect estimated uncrossing prices after they are placed, and looking for strong price movements immediately following auctions could indicated signs of gaming.
Tim Wildenberg, CEO of Neonet, said: “Brokers are going to have to ensure they’re ready for the new auction on the LSE, which does create some cost pressure, particularly in firms where algo development is not their priority.”
The midday auction was consulted on last year and has received strong buy-side backing. The LSE has said it wants to provide an opportunity for institutional investors to trade blocks on a lit market.
Its existing open and close auctions already see larger average trade sizes than during continuous trading, and the new auction has also been timed to coincide with the time when many fund managers recalculate their benchmarks.
“We’re seeing a lot more competition in the very important auction space,” added Wildenberg, “The LSE is introducing a new auction and we’ve also recently seen Aquis launch a new auction-oriented order type.”
The LSE’s midday auction is due to launch as part of its next major technology update, due in the summer.