Traders favour ‘fill-me-now’ approach as volatility continues

The unprecedented volatility that has shaken the financial markets in recent weeks has given rise to more aggressive and opportunistic trading strategies by institutional investors.
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The unprecedented volatility that has shaken the financial markets in recent weeks has given rise to more aggressive and opportunistic trading strategies by institutional investors.

This week, prices in several stocks have fluctuated in excess of 30%. In September, the UK’s FTSE 100 index wavered between 4800 and 5000 points, before plummeting to below 4400 at the beginning of October, and even falling below 4000 as markets opened today. This has made the need to act quickly a top priority for buy-side traders wary of the potential negative consequences of being caught out by rapid changes in sentiment.

“When you have sharp dips followed by steep spikes as we’ve seen this week, the opportunity cost can be colossal if you go in on the wrong timing,” said Anthony Kirby, director, Financial Services Advisory – Regulatory & Risk Management, Ernst & Young. “It makes sense to get into and out of the market as quickly as possible: latency matters. You also see a lot of aggression driven by the need to participate, for example in small- and mid-tier stocks.”

“The downside is that the relative footprint/market impact that this can have,” Mark Winter, head of dealing at Insight Investment, the asset management arm of HBOS, told “However, in hindsight, it has proved to be the right decision in the last few weeks as the absolute move of the stock price outweighs having two or three times the market impact you would usually inadvertently create, especially where swings in stock prices are 15-20% if not more,” he said.

Chris Jackson, director of EMEA execution sales, Merrill Lynch, confirmed that execution algorithms have been preferred by buy-side traders to reduce time to market. “In a risk- sensitive environment, people are using algos because they carry out the instructions to the letter, and there is no degree of variation,” he said.

The increased appetite of institutional investors for more immediate strategies has naturally led to more demand for risk pricing. But with the banks’ balance sheets taking a battering, coupled with the abnormally high level of risk, this has come at a price.

“There is an appetite from my fund managers – for immediacy and ‘fill me now’ type approaches – to get risk prices, but this conflicts with the fact the sell side’s appetite for risk has evaporated significantly in recent times,” affirms Insight’s Winter. “It is still possible to get a price, but it’s more challenging getting a reasonable risk price from our regular providers than six weeks ago.”

Merrill Lynch’s Jackson said the sell-side is catering for demand for risk pricing. “We have a capital commitment algorithm on our algo platform,” he said. “This provides a price guarantee to clients and we have seen very high usage levels of that in recent weeks.”

Institutional investors still require a wide range of services from the sell-side, said Kirby. “From a low-touch perspective, algorithms need to be constantly re-calibrated to cope with the highly volatile trading environment. But this is equally a time for high-touch trading and some agency firms who don’t commit capital are doing well. Brokers should be adding value by helping clients derive a picture from the complexity. In such volatile climes, people want insight, not just data,” he said.

The current markets are also rewarding buy-side traders for taking an opportunistic approach to the price ranges they are plugging into their algorithmic execution strategies. “Using a ‘pick your limits’ strategy – however outlandish these limits might seem – in the current climate can have a realistic chance of getting filled compared to what we used to consider as a normal environment,” says Winter. “We are seeing anomalous price spikes, and if you are there at a cheeky limit, you can sometimes take advantage of that and execute a trade in a stock at a price you would not normally expect to see.”

Multilateral trading facilities (MTFs) have also emerged as beneficiaries of market volatility. Volumes at platforms such as Chi-X and Turquoise have been boosted by stat-arb traders looking to capitalise on price discrepancies between trading venues.

Kirby said trading between the spread by stat arb hedge funds and hedge fund market makers could “easily” account for 15-20% of market volume on a given day. “One of the reasons they can trade between the spreads is because MTFs have finer tick sizes than some primary exchanges,” he observed.

“We have found we are able to get access to more liquidity through accessing primary exchanges and MTFs combined via our smart order router rather than just trading on the incumbents. Chi-X has performed particularly well, both in terms of latency and their overall ability to handle volumes of flow,” noted Jackson. “This means that it is a testing time for smart order routers, which need to be robust enough to take advantage of this.”

According to Jackson, Merrill Lynch executed in excess of 218 million shares on Chi-X on 8 October, over double the 100 million landmark that was reached on 17 July. Winter said that upwards of 25-30% of Insight’s pan-European agency program business has been executed on Chi-X, “At the moment, I’d be reluctant to leave more than a modest proportion of an order in a dark pool in case any other volume passes us by,” he said.

But Thomas Richardson, global head of transaction services at NYFIX, which operates the Millennium and Euro Millennium dark pools in the US and Europe respectively, said that dark pools with high levels of connectivity had seen an increase in volumes. “Over the last several weeks, market turmoil has translated in a reduced appetite for risk, which has meant much more agency trading and algo trading,” he said. “We are direct beneficiaries of that as our dark pool is open to everyone, including algos and smart order routers, unlike some of the other dark pools.”