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Trading Technology

03:32 PM
Katherine Heires
Katherine Heires
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Advice for the Custom-Algo Set

Customizing algorithms is not for the faint of heart. Research and openness between broker and buy-side trader is a must.

If you're a buy-side trader thinking about making adjustments to a sell-side-provided algorithm, be sure to do your homework, stresses David Mortimer, the New York-based managing director of algorithmic and program trading at investment bank Piper Jaffray. And don't be afraid to ask to meet in person with a sell-side firm's quantitative/development team to ensure that you understand the algorithm and are making full use of its capabilities and built-in adjustment tools, he adds.

While Mortimer points out that he does not get many requests to alter the working structure of an algorithm, there is a small and possibly growing percentage of his client base that has made such requests - due, in part, to the growing sophistication and understanding of algorithms on Wall Street. "It is a very small and rarefied audience of buy-side traders who have the technical, in-house capabilities to actually customize algorithms themselves to meet their own needs," Mortimer says, noting that index funds and select hedge funds would fall into this category.

Gavin Little-Gill, senior analyst with the investment management practice at TowerGroup, notes that the current market for customization inevitably will grow as buy-side traders become more savvy about algorithmic offerings and as the sell side starts to introduce more-complex products, such as cross-asset-class algorithms.

Nevertheless, Mortimer reports that Piper Jaffray has made adjustments to its roster of eight algorithms to meet specific client needs. The changes included everything from customizing an algorithm from the ground up in order to change its volatility assumptions to far more-minor tweaks, such as changes to the order routing or what trading venues the algorithm chooses during the course of a trading day. Mortimer also notes that some custom algo business has come Piper's way because a number of its competitors will not provide buy-side clients with direct access to their quantitative/development teams.

One buy-side trader - the head of algorithmic trading at an asset management company with more than $200 billion in U.S. equities under management - confirms that his decision to work with Piper was due in part to his ability to meet with the firm's quantitative/development team. The trader, who requested anonymity, says he originally hoped to meet with the developers at another firm to gain a better understanding of how an algorithm worked and then make changes that would better suit his trading strategy. "How can I go in front of a mutual fund board holding up a 'best execution' banner when I don't really understand how a particular algorithm works?" he relates.

To the trader's dismay, the response was: "We can't introduce you to the team - our quantitative development team and their work is proprietary." Piper Jaffray, however, was one of a handful of firms that was willing to provide access to their quantitative/developer teams. Other firms willing to do so included Investment Technology Group (ITG), Merrill Lynch, Susquehanna and Weeden & Co., according to the trader.

Ultimately, the trader chose to work with Piper Jaffray. And, after a 15-hour session with his entire trading team and Piper's developers and quants, he was able to make educated requests about how to adjust a particular algorithm to his firm's liking, he says.


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