Tapping into the human block network

While electronic order books have now supplanted open outcry trading all over the globe, human interaction on the NYSE floor can still offer a significant source of liquidity for buy-side institutions, according to Harish Devarajan, CEO of Deep Value.

While electronic order books have now supplanted open outcry trading all over the globe, human interaction on the NYSE floor can still offer a significant source of liquidity for buy-side institutions, according to Harish Devarajan, CEO of Deep Value.

Deep Value is a provider of algorithms and other trading tools to traders on the floor of the New York Stock Exchange. The firm also has a brokerage subsidiary, Deep Value Enclave, through which it offers algorithms to buy- and sell-side firms.

Although many exchanges have decided to eliminate floor trading altogether in favour of electronic means, NYSE has opted for a hybrid model following its take-over of Chicago-based electronic stock and derivatives market Archipelago in 2005.

NYSE used the acquisition to revamp its trading floor with the introduction of designated market makers (DMMs) – firms that are required to maintain a fair and orderly market for NYSE-listed securities via physical and electronic auctions. It also adopted the use of handheld devices that let brokers deploy algorithmic trading strategies which interact with the electronic order book and are developed by NYSE or third-party providers like Deep Value.

But the NYSE floor also offers the chance for brokers to develop trading relationships with DMMs – firms such as GETCO, Barclays Capital and Knight Capital.

According to Devarajan, the NYSE floor retains the importance of human relationships and can help institutional investors transact blocks more efficiently.

“Floor brokers are essentially part of a human block trading network, with the ability to trade against other brokers with similarly large orders from institutions,” he said. “Brokers frequently have decades of experience with counterparts on the floor to assess their credibility at delivering reasonably-priced liquidity, and they are able to use that to their customers’ benefit. Block trading involves revealing information selectively in return for higher fill rates. This is a very delicate line to toe, and with anonymous, automated means, this line sometimes gets crossed more than is in the customer’s interest.”

Floor traders also operate under a parity framework, a model that enables orders from multiple floor brokers and DMMs to trade together, with the aim of facilitating execution for all competing orders at the same price point.

Floor brokers who set the best price for a trade obtain a larger allocation of the available shares, but the remaining balance of shares are distributed equally at that price point to the remaining participants.

“NYSE as a liquidity center brings an element of parity to the trading process,” says Devarajan. “This lowers the advantage of having the most fleet-footed technology, and instead benefits investors by increasing their chances of trading with natural counterparts, rather than just the fastest ones.”

To support the continued development of its floor trading algorithms, Deep Value added 16 full-time employees to its development team in Chennai, India last year. The firm claims to have one of the largest teams in the world whose primary focus is on research and development of algorithmic trading in US markets.

Deep Value processed over a third of a trillion dollars in trading volume last year and reported its single highest trading day in December, accounting for 1.8% of US-wide stock market trading volume.

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