03.22.2013

Capital Markets Eye Change

03.22.2013
Terry Flanagan

Change at the market structure and individual firm levels should be undertaken with a view toward managing unintended consequences, market participants.

This means applying a disciplined approach to change management, with careful calibration of anticipated results to actual results.

An example is decimalization, which is widely blamed for causing dislocations in the market by reducing bid-ask spreads, and therefore harming liquidity.

“In the U.S., there is a lot of talk about doing more controlled experiments, as in decimalization, where they implement one change at a time for part of the marketplace to study the implications directly,” said Michael Aitken, CEO of Capital Markets Cooperative Research Center, and Australian academic center for capital market research. “In a controlled experiment, you only change one part of the marketplace at a time.”

The Securities and Exchange Commission, at a roundtable discussion on decimalization recently, heard testimony that indicated wide dissatisfaction with decimalization, tempered by a desire to avoid wholesale changes that might create more problems than they solve.

At the roundtable, Jeffrey Solomon, CEO of Cowen and Company, recommendeded that the SEC initiate a pilot program that widens the bid/offer spreads for smaller capitalization stocks,” thereby fostering a healthy trading ecosystem to ensure that emerging growth companies find the necessary trading liquidity to return to the equity capital markets.”

In thinking about a pilot program, Solomon said are a number of factors the SEC should consider in order to make it successful.

For example, the pilot program should last long enough to allow for meaningful investment in fundamental research. Solomon recommended a seven year minimum.

“It will take time for Wall Street firms to ramp up their cost structure to provide research, so we would not expect to see significant changes to the IPO market for at least three years,” he said.

Also, the selected group of small capitalization stocks should not be permitted to trade in between the National Best Bid and Offer (NBBO).

“A wider tick increment means that trades can only be executed at that increment even if it is traded on an alternative trading system,” said Solomon. “If this is not clearly established, then the pilot program will not be successful at all.”

At the individual firm level, testing is a crucial component of implementing computer-based trading algorithms.

“Back testing is a fundamental part of financial engineering,” said the head of a San Francisco-based hedge fund that employs algorithmic trading. “You need the ability to simulate market activity with enormous amounts of data, which requires enormous CPU power. You need to build an environment to simulate stock trading and back test it at 100 times normal speed. In terms of algorithm development, there are as many strategies as there are people trading.”

Related articles

  1. Allowing algorithms to control the supply and demand of crypto was challenged by Terra Luna.

  2. CME Boosts European Energy Business

    Infrastructure and sustainability will be one of the biggest opportunities in alternative investments.

  3. The broker's algo development team gains access to high quality, granular Level 3 data.

  4. Trading Europe From ‘Across the Pond’

    Bank aims to gain share from its systematic approach to trading, market structure proficiency and modern techn...

  5. The firm will be rolling out algos for institutions to navigate crypto market structure.

Wordpress Management by Creating Digital.