Routing Analysis Gets Real (-Time)

Terry Flanagan

Buy-side traders seeking to minimize the market impact of their transactions are overlaying venue analysis with a more dynamic methodology that presents a fuller picture of the market’s moves before, during and after their trades.

Routing analysis takes the premise of venue analysis — determining where to execute trades and where not to — and factors in the interconnectedness of markets. Specifically, that a ping, cancel, replace, etc. to one venue can have profound implications for orders headed to another.

James Doherty, Dash

“Routing analysis provides actionable intelligence to help shape the routing process to meet performance objectives of the thesis, strategy or individual,” said James Doherty, Head of Equity Product at Dash Financial Technologies. “It provides insight into the logic and decision-making behind an order by showing the ‘how’ and the ‘why’ of an order’s execution.”

Doherty cited an example of a non-urgent but aggressive trade order that’s meant to probe for a mid-point execution on Venue A and then route the balance to Venue B. If the order takes liquidity from a market maker on A, that market maker might immediately pull a resting order from B. “Unless you view these steps together, the venue quality of B would look worse than A, but clearly the information leakage is coming from A,” Doherty said. “This is the value of routing analysis.”

A more general frame of reference is a subway system. Venue analysis can be likened to schedules and on-time data for individual lines; routing analysis is found in the control room, which shows that a 2 train being held at Times Square is delaying N and R lines.

The linchpin value-add of routing analysis is in how it enables institutional traders to buy and sell large positions, with less risk of giving away intent.

Roman Ginis, Imperative Execution

“The minimization of market impact remains the buy-side trader’s biggest challenge,” said Roman Ginis, a former quant trader with Point72 and UBS and now CEO of Imperative Execution, which recently launched the AI-assisted dark pool IntelligentCross. “The problem is being attacked on multiple fronts, with traders increasingly utilizing more advanced broker algorithms, executing on ‘smart’ trading venues like ours and leveraging sophisticated analytics for pre-, intra- and post-trade review.”

Routing analysis is an increasingly important arrow in the quiver of the buy-side trader, Ginis noted. “Extremely granular analyses of routing behavior is a critical step in understanding the underlying cause of slippage and remedying it,” he said.

Market Evolution

Decades ago, venue analysis wasn’t much of a thing in the U.S. stock market — blue chips traded on the New York Stock Exchange, and smaller-caps and tech names traded on Nasdaq. That started to change around the mid-2000s when Regulation NMS opened up the trading-venue landscape to competition, and Rules 605 and 606 mandated disclosure of order-routing information.

That new institutional trading landscape – with scores of lit and dark execution venues, tech-enabled market makers, co-location, ultra-fast data feeds and other features of modern market structure – rendered obsolete the legacy metric of Effective Over-Quoted, or “EQ”, which assessed the order execution price versus the national best bid and offer (NBBO). That opened the door for the buy side to ask for last-market prices for their fills and more transparency overall.

Venue analysis has improved over the years and is “absolutely needed by the buy side to benchmark their experience with peers and keep an eye on general venue quality,” Dash’s Doherty said.

But for firms that can implement it properly, routing analysis is the Waze app to venue analysis’s static GPS system. “By taking into account dynamic, real-time information, Waze offers much greater intelligence and usefulness,” Doherty said.

“Proper routing analysis requires you to measure not just the experience at one venue in isolation, but how it impacts others,” Doherty continued.

Which comes back to the raison d’etre of routing analysis — minimizing information leakage. “No matter how hard you try, some level of market impact is always going to be present. But you can control the pattern of the information that’s being leaked and therefore manage the market response,” Doherty said. “With routing analysis, traders can view the overall response of the market to their particular trading style and use that to further refine their strategies.”

The methodology can be used for short-term trading strategies as well as to generate operational alpha for long-term institutional investors. Said Doherty, “routing analysis is becoming increasingly critical to effectively trade today’s markets.”

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