Contents

Algorithmic Trading & DMA

An introduction to direct access trading strategies.
By Barry Johnson


Page
Preface xiii
Part I An overview of trading and markets 1
1Overview 3
1.1 Introduction 3
1.2 Fundamentals 5
1.3 Core execution methods 6
1.4 Institutional trading types 8
1.5 Electronic trading 10
1.6 Algorithmic trading 11
1.7 Direct Access Trading 15
1.8 Comparing execution methods 17
1.9 How much are these execution methods used? 21
1.1 Fears and myths 22
1.11 Summary 25
2Market microstructure 27
2.1 Introduction 27
2.2 Fundamentals 28
2.3 Market structure and design 30
2.4 Trading mechanism research 39
2.5 Transaction cost measurement and analysis 47
2.6 Summary 51
3 World markets 53
3.1 Introduction 53
3.2 Asset classes 54
3.3 Market structure 58
3.4 Global market trends 66
3.5 Global market comparison 74
3.6 Summary 78
Part II Algorithmic trading and DMA strategies 81
4 Orders 83
4.1 Introduction 83
4.2 Market orders 84
4.3 Limit orders 85
4.4 Optional order instructions (Duration, session, fill, routing, linking etc.) 88
4.5 Other order types (Hybrid, conditional, hidden, routed, crossing etc.) 96
4.6 Summary 112
5Algorithm overview 115
5.1 Introduction 115
5.2 Categorising algorithms 116
5.3 Common features of algorithms 118
5.4 Impact-driven algorithms (TWAP, VWAP, POV etc.) 119
5.5 Cost-driven algorithms (Implementation Shortfall etc.) 132
5.6 Opportunistic algorithms (Price inline, liquidity-driven etc.) 143
5.7 Other trading algorithms 154
5.8 Summary 160
6Transaction costs 161
6.1 Introduction 161
6.2 The investment process 162
6.3 Pre-trade analysis 165
6.4 Post-trade analysis 167
6.5 Breaking down transaction costs 173
6.6 Transaction costs across world markets 184
6.7 Summary 186
7 Optimal trading strategies 189
7.1 Introduction 189
7.2 Assessing the difficulty of orders 190
7.3 Selecting the optimal trading strategy 192
7.4 Choosing between trading algorithms 199
7.5 To cross or not to cross? 211
7.6 Market conditions during the 2007-09 financial crisis 213
7.7 A decision tree for strategy selection 214
7.8 Summary 217
Part IIIImplementing trading strategies 219
8 Order placement 221
8.1 Introduction 221
8.2 Price formation 222
8.3 Price discovery/Order matching 226
8.4 Order placement decisions 234
8.5 Dealing with hidden liquidity 247
8.6 Estimating execution probability 252
8.7 Summary 254
9 Execution tactics 257
9.1 Introduction 257
9.2 Designing execution tactics 258
9.3 Algorithm selection 270
9.4 Summary 275
10Enhancing trading strategies 277
10.1 Introduction 277
10.2 Forecasting market conditions 278
10.3 Estimating transaction costs 292
10.4 Handling special events 300
10.5 Summary 309
11Infrastructure requirements 311
11.1 Introduction 311
11.2 Order management 312
11.3 Algorithmic trading 322
11.4 Other requirements 334
11.5 Summary 337
Part IVAdvanced trading strategies 339
12Portfolios 341
12.1 Introduction 341
12.2 Portfolio risk 342
12.3 Transaction cost analysis for portfolios 351
12.4 Optimal portfolio trading 352
12.5 Portfolio trading with algorithms 360
12.6 Summary 367
Addendum A: Covariance 369
13Multi-asset trading 371
13.1 Introduction 371
13.2 Multi-asset trading strategies 372
13.3 Utility strategies (FX cash trades, covering shorts) 374
13.4 Structured strategies 374
13.5 Hedging strategies (Beta, duration, gamma/delta) 375
13.6 Arbitrage strategies (Basis, index, ETF, futures and option) 383
13.7 Adapting algorithms for multi-asset trading 397
13.8 Summary 400
14News 401
14.1 Introduction 401
14.2 Types of news 401
14.3 The changing face of news 404
14.4 Computerised news handling techniques 409
14.5 Market reactions to news 416
14.6 Incorporating news into trading strategies 432
14.7 Summary 437
15 Data mining and artificial intelligence 439
15.1 Introduction 439
15.2 Data mining 440
15.3 Artificial Intelligence 448
15.4 Incorporating in trading strategies 461
15.5 The future 468
15.6 Summary 469
Epilogue 471
Appendices 473
A Equity markets 474
B Fixed income markets 495
C Foreign exchange markets 504
D Money markets 509
E Derivatives markets 515
F Other markets 534
Abbreviations & Acronyms 543
References 545
Index 569