Algos Pass Volatility Test According to Tabb Research

According to Tabb Group’s annual buy side report, “U.S. Institutional Equity Trading: Crisis, Crossing and Competition,” algorithm usage has held up despite recent high volatility and market turmoil.

During a Webinar presenting this year’s findings, Laurie Berke, senior consultant at Tabb Group and author of the report said, “No one really knew if they would with such huge amounts of volume and record volatility, but algorithms withstood the test.”

She added that this shows users “had solid confidence in their ability and the infrastructure.” The Tabb research predicts that algorithm usage will continue to grown through 2010.

The report also revealed that the top five algorithm providers by commission, year to date, were (in order) Credit Suisse, UBS, ITG, Citi and Goldman Sachs and Merrill Lynch were tied for fifth.

Buy siders reported that when choosing their algorithm provider, the number one factor was performance, followed by technology (ease of use, linkages, etc) and their overall relationship with the broker.

The Tabb research broke the algorithm market down further and found the top providers based on percentage of market share. This calculation took into account average daily volume of the buy side traders interviewed and information about how they allocate their order flow.

The top providers by market share were number one Credit Suisse, Goldman Sachs and Morgan Stanley tied for second, ITG in third, JP Morgan in fourth and UBS in fifth. “Large firms use an average of ten algorithm providers,” said Berke.

She said that despite volatile trading times and market turmoil, buy side traders reported they did not use algorithms less frequently than they had in the page and one third reported using algorithms more this year than last year.

“Nobody shied away from using algorithms but they are more hands on,” said Berke. “They want providers to offer more tools to tweak their orders or change strategies and to make that easy. Traders are also watching their algorithms like a hawk.”

Berke said that over the past year, particularly during the high volatility times, buy side traders want more control over their algorithms and aren’t experimenting as much. “They want to stick with the providers whose algorithms they understand and where they know they’ve gotten performance,” said Berke.

The report also asked traders what algorithm providers could do to improve their experience and although the first ranked response was nothing, the second highest response was transparency, followed by transaction cost analysis, greater anonymity, customization toolkits and broader linkages.

The Tabb research is based on interviews with 61 buy side traders at large, medium and small firms beginning in August of 2008 and continuing through the beginning of October.