Poor routing decisions, caused by overlooking features of different displayed markets that can affect execution quality, could be costing US investors up to US$4.5 billion per year, according to a new report.
The paper by consultancy Woodbine Associates, titled ”US equity exchange performance 2010', looked at differences between markets in terms of price improvement and the sophistication of different participants.
“We believe there are differences between displayed markets that are measurable and aren't as well recognised among market participants as they should be,” Matt Samelson, principal, Woodbine Associates, and author of the report, told theTRADEnews.com. “It is imperative to look at the different types of participant in a respective venue and their ability to move prices and game others.”
The report found that for most securities, the best combination of price improvement and an unbiased trading environment could be found on Direct Edge's EDGA exchange and BATS Exchange's BYZ market.
For NYSE-listed securities, the New York Stock Exchange was found to favour liquidity takers at the expense of liquidity providers, who are prone to being gamed, while Nasdaq OMX exhibited the least beneficial price improvement of all major listings in all but the smallest of its own listings.
While Samelson said he was surprised that EDGA was included among the best venues for NYSE-listed securities, given that it offers no charge for liquidity takers, he noted that NYSE's supplemental liquidity provider programme comprises a number of high-frequency trading firms that may have contributed to its negative results.
A further reason that market participants may be receiving sub-optimal routing for their orders is a lack of clarity on where trades are sent as part of algorithmic strategies.
“Buy-side firms are only just starting to look at where the child orders generated by algorithms are executing, and if the decisions made on their behalf are really in their interest or more to do with a broker trying to benefit from the pricing schedule of the exchanges,” said Samelson.
To ensure their orders are routed to the best place, Samelson urged buy-side traders to ask more questions of their brokers when it comes to execution performance. But he did recognise that this may not be as simple as it seems.
“Firm can become completely overwhelmed at the prospect of granular execution analysis because it is a highly data intensive process,” he said. “Best execution requires access to the right type of data as well as a framework and a process in which to evaluate this data on a regular basis.”