Low Latency Doesn’t Mean Best Execution

Terry Flanagan

With all the din about high-frequency trading, it’s easy to lose sight of the fact that for the vast majority of asset managers and traders, low latency is not nearly as important as ensuring they are getting their orders completed within a certain time.

Some managers, for example, may prefer to buy near the lows and sell near the highs, while others might employ a momentum-based strategy where stocks may be bought or sold based on some exogenous event. In any case, the speed with which a message gets transmitted (i.e., latency) is less important than the certainty with which an order is executed.

“Latency has very little to do with best execution,” said Bill Conlin, CEO of Abel/Noser. “Latency might account for a fraction of a cent in terms of overall execution, but if you trade at the wrong time of the day, you’re talking about dollars of impact, not cents.”

Abel/Noser Corp. has re-launched its monthly liquidity analysis that provides investors with clear, concise trading information during this time of uncertainty. Going forward, this report will be made available 10 days after the end of the month and will outline the top 20 liquidity figures for the month.

“Given today’s market volatility, it is vital that investors are provided with timely insights into what trends are actually impacting the trading environment,” said Conlin. “Often on Wall Street, brokers and other vendors tout the speed at which they can transact equity trades. With ‘nanoseconds’ and ‘latency’ being the buzz words, it may lead people to believe that thousands of stocks are trading at the speed of light all day every day, which is simply not the case.”

The advent of HFT may actually have more to do with regulations and market structure than with latency, according to Haim Bodek, CEO of Decimus Capital Markets, a trading firm that aims to take advantage of market structure shifts in the U.S. equities space.

Haim Bodek, Decimus Capital Markets

Haim Bodek, Decimus Capital Markets

“The important thing to understand is the adoption of Regulation National Market System (Reg NMS) coincides with a period of intense HFT volume growth,” Bodek said in a presentation. “U.S. equities market structure has evolved to tilt the balance in the favor of discretionary high frequency trading (HFT) liquidity providers, creating new challenges for effective liquidity sourcing by financial institutions.”

In the electronic marketplace, algorithmic trading strategies must be designed to effectively interact with HFT participants, regardless of the expected time horizon for holding positions.

Without advanced tools for liquidity pooling, sourcing and provisioning, financial institutions subject themselves to a persistent adverse selection bias, resulting in unreasonable near-term slippages, the inability to execute against perceived opportunities and escalating transaction costs, according to Bodek.

Abel/Noser offers analytics throughout the pre-trade, execution and post-trade cycle, including Transaction Cost Analysis (TCA), domestic and international commission recapture for equities and fixed income, transition management, liquidity analysis and customized algorithms.

Abel/Noser’s analysis provides insights into how stocks trade.

About 13,000 equity issues were traded in the U.S. during May 2013; this included ETFs and individual company stocks. The 523 most liquid stocks accounted for 75 percent of all dollars traded in U.S. equity markets.

“Of all of the names in our liquidity analysis, on average only 184 trade one time or more per second, with the largest (SPY) trading six times per second and the second largest three times per second,” said Conlin. “Given that less than 2 percent of U.S. equities are even subject to high-frequency trading, the investor community should focus more on efficient and cost-effective trade execution instead of low-latency.”

Aside from discrepancies when it comes to speed, share size is also commonly misunderstood. There are very few stocks with an average trade size of greater than 400 shares. Once one is below the stock ranked 143 in average daily trading values in dollars, the average trade size drops to below 300 shares per trade.

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