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Pre-Trade Analysis

Brokers are developing pre-trade analytics in connection with their algorithms to help buy-side customers determine the best algorithms to use.

The Issue Defined: Brokers are developing pre-trade analytics in connection with their algorithms to help buy-side customers determine the best algorithms to use. These tools will help traders calculate the expected market impact of potential trades.

Why It's Important: Today, buy-side traders want immediacy and pre-trade analytics are tools that can be used at the trader's desktops rather than having to call a sales trader for the information. These analytics determine, for example, that a particular trade can be executed with less market impact. In the past, post-trade analytics were all that were available-analysts and portfolio managers would look at past trends to determine potential future outcomes. There is more emphasis on pre-trade analytics today because of the increase in electronic trading; instead of sharing assumptions on the market impact of a trade with a sales trader, buy-side firms have to interact with a black box.

Where the Industry Is Now: Virtually every bulge-bracket brokerage firm has developed or is developing pre-trade analytics to work with their algorithmic-trading strategies. Today's pre-trade analytics add expected market impact and historic correlations to various benchmarks in a more interactive application. However, while pre-trade analysis is the Holy Grail of transaction-cost analysis (TCA), it is not where traders need it to be: Pre-trade analysis works better on multidirectional basket trades (with buys and sells, longs and shorts), as opposed to individual stocks; and it needs real-time information, captured by the OMS. Often, the real-time data isn't available because brokers break large trades into multiple orders and give the buy side an average price for the entire execution rather than a separate price for each piece.

Focus in 2005: Brokers need to deploy pre-trade analytics to clients, likely through buy-side order management systems (OMSs). Meanwhile, the industry must agree on a benchmark for measuring pre-trade TCA: Volume-weighted average price (VWAP) and implementation shortfall are currently being used, but critics say VWAP can be manipulated. About 70 percent of the industry currently uses implementation shortfall as a benchmark for measuring market impact.

Who's Leading the Charge: Goldman Sachs' RediPLUS and Morgan Stanley's Passport provide the firms with the means to deploy pre-trade analytic tools: direct-market access platforms on their clients' desktops. ITG Citigroup offers a pre-trade basket model called StockFacts that is used on the buy and sell sides.

Some Vendors in the Space: QSG performs in-depth tick-by-tick TCA against various benchmarks. ITG offers ITG Logic, which is linked with ITG's automated trading servers and third-party OMSs, for pre-trade analysis. Portware and FlexTrade provide their own pre-trade analytics and broker algorithms. Third-party TCA services such as Plexus Group, owned by JPMorgan Chase, and Abel/Noser are getting into pre-trade analysis too.

Associated Costs: OMS vendors will make pre-trade analytics from brokers available but have not yet figured out what to charge for them. Customers want it for free.

Industry Perspective: "Because the algorithms are getting more complex, you can dramatically increase the trading costs by picking the wrong algorithm," says John Wheeler, vice president of equity trading at American Century. "As more and more portfolio managers adopt listing trading to diversify risk and slice their bigger portfolios' orders into smaller and smaller orders, these tools go hand in hand with that strategy," he says. Ivy is Editor-at-Large for Advanced Trading and Wall Street & Technology. Ivy is responsible for writing in-depth feature articles, daily blogs and news articles with a focus on automated trading in the capital markets. As an industry expert, Ivy has reported on a myriad ... View Full Bio

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