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Trading with the help of ‘guerrillas’ and ‘snipers’

Managers are increasingly using a variety of algorithms to aid trading strategies or detect
others’ algorithmic trading, says Paul Temperton, CFA*
The techniques used by fund developed by Credit Suisse, for These pools of liquidity will
managers when dealing in equities example, attempts to determine in typically not be shown on
will be the focus of greater real time which publicly displayed conventional trading platforms –
attention as three new (that is those on an exchange or those provided by the stock
developments come together. The trading platform) bids or offers exchanges or crossing networks –
first is the implementation, from can be hit or taken without a high and are therefore commonly
1st November, of MiFID, with its likelihood of causing jumps or a referred to as “dark pools of
new pre- and post-trade displacement in the stock’s liquidity”. Indeed, algorithms
transparency requirements for trading patterns. The technique is have been developed (for example
equity markets. useful for fund managers wanting Credit Suisse’s “Sniper”) to detect
to avoid moving prices against such hidden sources of liquidity.
Second, traditional models of themselves.
fund manager access to the Many of the algorithms used in
market – for example, via a “Participating” strategies can be the market have been developed
broker’s sales trader – are used to ensure that a certain by investment banks and are
increasingly being supplemented proportion of the trading volume supplied to their fund manager
by Direct Market Access (DMA) in a particular stock is captured. A clients. This raises the risk of
systems. A typical DMA system fixed percentage – or a range – of users of algorithms “gaming” the
involves the fund manager’s the trading volume in a stock can system.
broker providing him with the be specified by the fund manager.
required electronic trading tools The algorithm then assures that For example, an algorithm may
for him to route his trades directly the required proportion of trading trigger a buy order on a certain
to the market. volume is achieved. Such percentage upward movement in
strategies may appeal to a share price. But if such systems
Third, with this facility in place, “momentum-based” investors become widely used, then
“enhanced” DMA strategies and and fund managers who placing triggering such an algorithm can
algorithmic trading techniques are an emphasis on trends in volume be a useful way of generating a
becoming more feasible. Perhaps as an indicator that often better market price into which to
the most notable feature of these corroborate price trends. sell.
techniques is their diversity,
meaning that they can appeal to a Fund managers following indexed Not surprisingly, “sniffers” –
wide range of fund managers with or enhanced index strategies will another form of algorithm – can
different styles and requirements. also find a use for algorithm be used to detect the presence of
trading. “Benchmark” algorithms, algorithmic trading and the
Perhaps the most common form for example, can be used to algorithms they are using.
of enhanced DMA strategy is to achieve a specific benchmark, Bespoke algorithms are being
slice orders into smaller sizes. such as the volume weighted developed to overcome that
This can be with the intention of average price over a certain time problem.
hiding, or partially hiding, a large period. For such investors, the
order from other market shorter latency (that is, the lag Bespoke algorithms would be
participants, a technique between placing an order and it more difficult to “sniff out” and
sometimes called “iceberging”. being implemented) of although they would add to the
The maximum amount of shares algorithmic trades compared with current diverse range of
to be bought at any one time and those using more traditional algorithmic trading tools,
during a certain sub-period will be methods will help avoid any expected gains would have to be
specified by the fund manager. slippage between the price weighed alongside significant
Clearly, for a fund managers movements of an index and the development costs.
aiming to build a stake in a constituent components.
particular company and wanting *Paul Temperton is Course Director of
the FT Knowledge Portfolio
to disguise the extent of his One step up from these systems Management Academy which runs in
accumulation, such a technique is is “smart order routing”. With London from Monday 16th to Tuesday
useful. such algorithms, liquidity from 24th July 2007.
many different sources is
Slicing orders into smaller sizes aggregated and orders are sent out
can also be done with the to the destination offering the This article appeared in
intention of minimizing market best price or liquidity. FT FUND MANAGEMENT
On 19th March 2007
impact. “Guerrilla”, an algorithm


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