Empowering the Buy-Side Trader


This is the second part of a sponsored series from CODA Markets. The first was a chat with Don Ross, CEO of CODA parent PDQ Enterprises.

The trader who trades best, helps himself.

The institutional trader searches for the best data, broker, venues, order types and the list goes on and on until actual execution. But what about his actual tools? How does he find them?

Don Ross, CODA Markets

Having the best tools available allows a trader to maximize  alpha and execute trades in the most efficient manner, while minimizing adverse price selection, information leakage and slippage. While much has been made about the evils of predatory traders when it comes to protecting investor interest and how they are almost unbeatable despite regulators’ efforts and exchange-based speed restrictions, traders still need to look after themselves.

So, what if the buy-side took matters into its own hands?

Don Ross, Chief Executive Officer at PDQ Enterprises, parent company of CODA Markets, told Traders Magazine that instead of waiting for either the Securities and Exchange Commission to issue new regulations and find a silver bullet, or – as doubtful as it seems – having exchanges focus on the buy-side’s needs over those of high frequency trading firms that often are their source of liquidity, traders need to proactively come up with their own solutions.

In other words, the best defense is a good offense.

“The fact is, investors can quickly improve their competitive position – bringing better fills and stronger performance – by taking just three steps,” Ross began.

First, buy-side traders can set new benchmarks. Ross argued that while VWAP is widely used it’s a failure as a benchmarking tool.

“It does little to tell you if you got a good fill based on where the market was when you decided to buy or sell; it only tells you if each of the pieces you broke your larger trade into were executed acceptably,” he said. “It all starts with the benchmark.”

And the problem is that VWAP doesn’t tell a trader anything until he starts to actually trade and create a history. So, a trader’s first orders are done “in the blind” and nothing is known beforehand about potential market impact. Ross advocated using either a type of liquidity protection rule (LPR) calculator, which itself is a pre-trade benchmarking tool available via select vendors and CODA, or its own block auction process – CODA Block.

“The LPR helps safeguard a trade by adding limit up/limit down protection on a symbol by symbol basis,” Ross explained. “This is a great place to start as it anticipates where you could go.”

Add to this the CODA Block auction – which conducts a 30 second auction that includes issuing symbol-only alerts while gathering bids and offers both inside and outside the NBBO. The trader can use this as a means of price discovery and control just what he wants to do and perhaps place a more aggressive order.

“The goal here is have no stupid looking prints,” Ross chimed.

And the buy-side agreed. It wants to get the best trading experience and not be subject to extraneous forces.

”As part of our price discovery process we believe incorporating on-demand auctions into our trading workflow improves our TCA performance, because it allows us to seek out trading opportunities on our own terms,” said Luke Lyons, Managing Director and Global Head Equity Trading at Guggenheim Partners.  “When you know what price you’d be happy to pay for a stock, on-demand auctions are a very effective tool for safely discovering that unique liquidity.”

A second thing a trader can do to help empower himself is to make other traders play his game. In order to execute the biggest block trade and minimize information leakage, the key here is to not either consciously or automatically via algorithms slice and dice the initial large order into smaller child orders. Child orders, while perhaps more easily executable, fall prey to the ultra-low latency HFT crowd, multiple trades and eventually adverse price selection.

“You want to make these guys come to your block order,” Ross said. “The ideal number of trades is one but there are tradeoffs – such as market impact versus markup.”

In other words, if a trader wants size then he’ll have to reach across the spread.

“Sometimes the grass is greener on the other side of the spread and investors should get comfortable with a price outside it if that’s what it takes to get a full trade done at once,” he said. “Exchanges don’t provide this facility – except on open and closing auctions – to negotiate how much markup for a certain size – you can only transact with what is posted. It might be better to use a minimum quantity and an auction.”

Lastly, the buy-side trader can adopt a less-price sensitive strategy overall once he has a trustworthy benchmark and an auction that gets the desired size. Ross added that there are times when traders want or should cross the spread and other times when they shouldn’t – but the idea is that the trader should have the tools to decide for himself what to do.

“The well-intentioned SEC and the exchanges could possibly stumble upon a perfect solution to give investors a fair-trading experience,” Ross said. “But until that happens, investors should take matters into their own hands by following the above steps.”

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