Communication Is Key to Survival

The Liquidity Factor
Changes in liquidity have increased the need to use algorithms, crossing networks and DMA solutions. The days of using one trading system for all your trading needs are gone. As a result of regulatory changes, liquidity has become increasingly fragmented, and traders have become miners or hunters for liquidity.

A central marketplace? Only those of us who have been in the business more than 10 years actually know what that means. The move from fractions to decimals, looser margin requirements, Reg NMS and the slow death of the specialist system all contributed to the death of liquidity. I must sound like an angry old man, but there was a time and a place when liquidity existed and markets traded efficiently. Back then the specialists’ sole purpose was to maintain an orderly market for a group of stocks or a single stock. They determined the price and worked to correct any imbalances. Sometimes this meant a delayed opening or a halt to trading, but you always knew where you stood with the stock.

The recent volatility we experienced, especially in the bank stocks, would have been less severe if the old specialist system still existed. Remember the day that State Street and Bank of New York were down 20 percent solely on the speculation that they were the next two banks to fail? I remember the days when I could send an order to the NYSE with a limit price between the posted bid-and-ask and execute my whole order — days when you could execute a 5,000-share order in one print at one price. Now that was true liquidity. Compare that to today’s environment, where there are 100 price points that could generate hundreds of prints at an average price.

Today everyone hides in dark pools. There are so many of these venues that you get a piece of liquidity here, a piece there. Is this really an efficient way to trade? Your systems have to have the ability to ping all of these liquidity venues or else you will be left out in the cold. Try telling your portfolio manager that you didn’t get filled because you did not have access to a particular destination.

Keep Everyone in the Loop
“You learn something new every day.” I love that expression. It’s one of the many reasons I love this business.

You would think that in turbulent markets, communication would be a no-brainer between portfolio managers and traders. But this is a complicated issue. It depends on how involved or not the head trader/trading desk is in the investment process, and on how hands-on the portfolio manager might be. For traders to be effective, they need to know all of the information surrounding a trade. For example, is the PM in the office or on the road? How urgent is the limit? Is there any flexibility or range of price? Does the PM want all or part of the program completed?

When these issues are not addressed, a situation such as this could occur: The PM gives the trading desk at 10:30 a.m. a sell program for XYZ with a limit. The desk completes the sell program by 2 p.m. The PM comes back to the desk at 3 p.m. with more XYZ to sell at the same limit as before. The stock is away from the limit and the PM will not be available until after the market closes. About five minutes before the close the stock comes into the limit. The desk only completes a small amount of the order.

The PM sees the closing price and thinks he is done. Due to his timing, however, he is not done. If he had given the whole program to the desk in the morning, he would have been completed. In addition, if he was available, the desk could have asked him if he wanted to change the limit to get it done.