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Nasdaq Launches Algo Trading Test Facility

Nasdaq will launch a cost effective solution for broker dealers to manage risk exposures, and understand economics around new trading strategies.

NASDAQ OMX Group and Thesys Technologies have partnered to offer a trading algorithm test facility, a testing environment that will simulate trading on all major US equity exchanges. It is expected to launch in Q1 2014.

Because a significant portion of trading volume is generated algorithmically, testing is key to maintain industry compliance. The Algo Test Facility will enable users to rigorously examine algorithmic strategies by replaying and interacting with real historical market data, according to the press release. The facility will also provide reports that show the quality of the quote processing, latency, all the way down to the order handling.

Stacie Swanstrom, head of access services at Nasdaq OMX explains the Algo Test Facility is intended to provide traders with valuable insights about risk and performance, including the ability to evaluate the cost of adverse selection for specific trading strategies. The reports from simulations will help firms decipher if things worked the way they expected, and there will be criteria in the reports to help them examine the output.

Economic Value

Thesis Tech, the infrastructure affiliate of Tradeworx, is the power behind the testing facility (also known for powering SEC Midus software). Manoj Narang, CEO of Tradeworx says, "We think there are also valuable economic insights to gain by simulating strategy before launching them."

For example, the people who build strategy also build parameters. With the test facility, users can test multiple parameters to see which ones are best in different environments.

"It costs money to be faster, and you can't possibly make decisions about that tradeoff. We help people quantify that for the first time... This is the first tool we're aware of that allows you to measure economic impact of latency on trading systems. You'll be able to see how much better or worse you would have of done if you were 100 microseconds faster or slower."

[For more on Nasdaq see: Why StockTouch Moved Gamer Mechanics onto Nasdaq's FinQloud]

Essentially, adds Swanstrom, it’s a cost effective solution for broker dealers to manage risk exposures, and more importantly to understand economics around new trading strategies. "When a market participant, whether they be from the sell-side or the buy-side, is gearing up to implement new automated trading strategies, they can now simulate real market situations on a specific day to measure the financial impact. This tool enables market participants to make necessary adjustments before going live."

Risk & Compliance

Broker dealers are struggling to get ahead of regulatory mandates, and Nasdaq admits there have been challenges over last couple years. "Regulatory bodies are looking closely at operational risk management in a complex environment where technical difficulties are all part of the market structure weather,"" says Swanstrom. "So the financial services community is trying to be proactive and concentrate on alpha generation… There is a business incentive to perform tests for the protection of your firm and for the protection of the larger market."

"We are pretty sure it's impossible to build testing systems that can guarantee stability of trading systems, the best you can do is minimize errors, and that's a worthwhile goal," observes Narang. "Glitches in the marketplace occur for various reasons. Regulation covers certain critical systems that exchanges, clearinghouses and some broker-dealers operate, but there's little in the way of actual substance that comes to testing of algorithms, which have been somewhat destabilizing in the past." Knight Capital and the flash crash were both caused by rogue algorithms. "While I think it's impossible to completely reduce risk, you can ask market participants to do their best to cut the risk. That's what this is intended to do."

Infrastructure

According to Narang, the principal technology challenge was adapting the systems to speak FIX protocol and native protocol of all exchanges. Nasdaq's was the first functionality adopted.

NASDAQ is allowing market participants’ trading systems already co-located at its data center in Carteret, New Jersey to simulate their algorithms in the real market environment, interacting with historical data from the entire marketplace.

The Algo Test Facility is a stand alone product, not packaging with other NASDAQ services or test services. According to the press release, the first phase of the Algo Test Facility will include simulations for the NASDAQ Stock Market, and over time the test system plans to support all major U.S. equities exchanges along with their order types and protocols so user activity may interact with the historical orders of other market participants.

Becca Lipman is Senior Editor for Wall Street & Technology. She writes in-depth news articles with a focus on big data and compliance in the capital markets. She regularly meets with information technology leaders and innovators and writes about cloud computing, datacenters, ... View Full Bio

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Becca L
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Becca L,
User Rank: Author
10/17/2013 | 2:28:10 PM
re: Nasdaq Launches Algo Trading Test Facility
As Narang said, "We are pretty sure it's impossible to build testing systems that can guarantee stability of trading systems" - traders can only do their due diligence up to a point, and I see it no way regulators can ask for anything more.
Becca L
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Becca L,
User Rank: Author
10/17/2013 | 2:23:57 PM
re: Nasdaq Launches Algo Trading Test Facility
Slip of the tongue, I think. But it was a solid analogy. Algos can be incredibly damaging, and algo testers can really help fine tune that destruction if the tester was so inclined.
Greg MacSweeney
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Greg MacSweeney,
User Rank: Apprentice
10/17/2013 | 12:18:38 PM
re: Nasdaq Launches Algo Trading Test Facility
LOL. I think the algo testing platform founder needs to hire a marketing or PR person. "We give them the gun, but we don't tell them to shoot people with it" is probably not the best sales pitch! ;)
Becca L
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Becca L,
User Rank: Author
10/16/2013 | 11:55:54 PM
re: Nasdaq Launches Algo Trading Test Facility
Perhaps it's only a matter of time (or a few more Knight incidences) before Reg SCi includes algos. Many of these algo testing platforms alert the tester if they are out of compliance and why, but doesn't necessarily stop them from trading it.

On that point, a few months ago I spoke with an algo testing platform and recall the founder saying, "We give them the gun, but we don't tell them to shoot people with it." Clever.
IvySchmerken
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IvySchmerken,
User Rank: Author
10/16/2013 | 9:34:25 PM
re: Nasdaq Launches Algo Trading Test Facility
Yes, testing must be tedious and it takes time away from trading but the alternative of no-testing is too risky give the number of market disruptions that have occurred. As you say, some of the benefits of the simulation are that firms can see if they're algos are economically viable and if investing substantial sums to lower latency is worthwhile. Still, for me, the overriding issue is that firms need to know if they're algos are behaving correctly in a real-time, complex environment, as best they can. I realize that doesn't mean that one variable or parameter couldn't interact with another algo on a busy day and cause mayhem.
IvySchmerken
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IvySchmerken,
User Rank: Author
10/16/2013 | 8:40:31 PM
re: Nasdaq Launches Algo Trading Test Facility
It seems like SCI should address algos, but some brokers want to be in charge of testing their own algos, and don't want the regulators to intervene. It's considered the responsibility of brokers to invest in the stability of their systems. If they send out faulty code, they may go out of business, as we saw with Knight and its $440M loss.
Greg MacSweeney
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Greg MacSweeney,
User Rank: Apprentice
10/16/2013 | 3:57:52 PM
re: Nasdaq Launches Algo Trading Test Facility
Hmm. Interesting. Yes, you are correct. SCI doesn't say anything about algos or other trading systems that may run at entities that are not covered by Reg SCi. That seems like a big hole, since algos are such a part of the marketplace now. Shouldn't algos be included?
Becca L
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Becca L,
User Rank: Author
10/16/2013 | 2:37:38 PM
re: Nasdaq Launches Algo Trading Test Facility
Yes, traders are eager to get ahead of regulation. I think it can be a tedious process, to test and retest before launch, including reviewing the corresponding reports, but Nasdaq is offering a lot of extra incentives with the economic value. It's definitely a high-value move.
IvySchmerken
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IvySchmerken,
User Rank: Author
10/16/2013 | 1:20:50 PM
re: Nasdaq Launches Algo Trading Test Facility
I agree. Reg SCI covers a number of areas including resiliency and testing of testings at exchanges and alternative trading systems and clearing firms, but it only covers broker dealers operating ATSs. I'm told it doesn't cover other types of technical mishaps that can originate at a broker dealer such as rogue algorithm.
gogreen-traders
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gogreen-traders,
User Rank: Apprentice
10/16/2013 | 11:47:05 AM
re: Nasdaq Launches Algo Trading Test Facility
This is a good first step in the right direction. Reg SCI will certainly mandate something like this in the future. Nasdaq is getting out ahead of the new rules, which is a good thing.
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