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Profound change can be rather subtle. While it is obvious that current events cause changes in the market that require adaptation by buy-side trading desks, it is not always obvious to what extent change becomes the new norm.
This year, conversations during the rollercoaster markets of August with 68 buy-side traders for TABB Group's annual buy-side equity study, "Coverage Under Fire," suggest that the needle on the dial has moved. Even if the VIX -- the Chicago Board Options Exchange Market Volatility Index -- trends southward again, the wheels on the permanent rollercoaster have been greased, and the tools on the buy-side trader's desktop need to keep up.
Perhaps surprisingly, only 47 percent of the buy-side traders interviewed by Tabb Group said they had actively changed the way they trade due to the volatile conditions. Most were at least busier, but the positive side of volatility and a sanguine approach were evident. Half-price sales create great investment opportunities, while others' fear of missing the rising tide may help a trader get out of a position at the high of the day.
And conversely to what may be expected, there was no rush to the sales trading desk for trading help; rather, there has been a tightening of the belt and settling in for the duration. Meanwhile, tolerance for new products is high, as 69 percent of survey participants said they use or anticipate using loosely named "next-generation" algorithms.
Such algorithms include adaptations of high-frequency-trading algorithms, alpha-generating or venue-analytical algorithms, and those that effectively bob and weave in the market so as to be undetectable by sniffer programs. Alternatively, they may be algorithms that simultaneously work the lit and dark markets, trade in blocks and fine slices, and work hand-in-hand with the smart router to access "good" liquidity.
Go With the Order Flow
It is not just market movements, but changes in the order flow that need to be considered. Investment in passive U.S. equity assets now represents an estimated 26 percent of asset funds, compared with 16 percent in 2007. Further, monthly ETF inflows continuously break records at the expense of investment and mutual funds, and the change in investment style results in different shapes of order flow landing on the buy-side trading desk.
And behind the order is the portfolio manager. For every portfolio manager shell-shocked by zigzag prices who wants to stay close to the VWAP, there is another who wants a block under his belt before lunch but will happily wait out the current turbulence for the balance.
So buy-side traders are at once more patient, aggressive, careful and opportunistic. They are both staying put and spreading out their trading. But from the range of views about survival tactics, one thing is clear -- buy-side traders are always on the lookout for out-of-the-box thinkers, next-generation tools that are honed to the current market environment and fresh ways of trading.
As long as trading systems held up -- and 80 percent of the traders said they encountered no issues -- the traders continued a steady use of the low-touch channels but expanded the number of strategies used, such as switching algorithms continuously, trading in the dark and trading at the close. Buy-side traders are calling for stronger, sharper tools, but they still want to own and control the toolbox.
Miranda Mizen is principal, director of equities research, for Tabb Group.