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Volatility Shakes Up Block Trading
By Ivy Schmerken
Feb 26, 2009
URL: http://www.advancedtrading.com/showArticle.jhtml?articleID=214600317
When Treasury Secretary Timothy Geithner unveiled his highly anticipated bank bailout plan Feb. 10, traders panned the strategy for a lack of details, causing the Dow to plummet nearly 382 points that day. That kind of reaction has made buy-side institutions skittish about leaving block trades waiting in traditional block crossing networks.
With uncertainty over the U.S. economy and volatility causing erratic intraday price swings in the stock market, buy-side traders say they are seeking fewer block trades while also finding it harder to execute blocks in traditional crossing networks. According to TABB Group estimates, block trading now accounts for 8 percent of total U.S. equity trading volume, down from 17 percent in 2006, which factors in retail, institutional, proprietary and principal-based flows.
"It's gotten harder to execute blocks in general," says Jennifer Setzenfand, a VP and senior trader at Federated Investors in Pitt*****urgh. Setzenfand, who utilizes institutional crossing network Liquidnet, says less than 10 percent of Federated's order flow comprises blocks.
Instead institutions are breaking up more orders and leveraging algorithms to work them throughout the day, traders say. At the same time, there also has been a shift to high-speed venues. In turn, however, this is making it even harder to execute blocks.
Fear Factor: Changes in Traders' Behavior
According to Setzenfand, volatility has changed the behavior of buy-side traders. On one hand, they fear they might get adverse prices if they place standing block orders in a dark pool, where they may need to wait for several hours to find a counterparty, she relates. On the other hand, "If I'm a buyer and the market is going down, I don't want to buy it early because it's going to be cheaper later on," Setzenfand adds. "If I put [a block] in a dark pool, I stand the chance of it all getting done, so I don't want to put it in a dark pool."
Until the volatility subsides, institutions will be leery of doing block trades, suggests a buy-side trader at a public retirement system in the Southwest who requested anonymity. "Because of this volatility, you don't want to be explaining why you bought stock and got the worst price of the day," says the trader, who uses traditional block crossing systems Liquidnet and Pipeline. "I'm still doing some block trading at certain price points on certain stocks, but overall probably less."
When determining how to trade a block-size order, Federated's Setzenfand continues, it depends on the direction of the market. "It's really about traders making directional calls on the stock and the sector and the market, and then deciding how to execute from there," she explains. "If something is coming my way, and I'm buying into the market and the stock is going down, I'm going to do small trades little by little, either the traditional way through a broker or using an algo to slice it."
So as volatility becomes the norm, traders want more immediacy with their executions and have begun to shift order flow to high-speed venues to mitigate uncertainty. According to TABB Group estimates, 70 percent of current trading volume is sent through direct-market-access (DMA) platforms or utilizes algorithms and black-box trading strategies.
"The traditional assumption is that volatility is generally not a good thing for block crossing network volumes," comments Justin Schack, VP, market structure, at Rosenblatt Securities in New York. "If the market is moving really fast, the benefit of waiting for a block counterparty to show up is balanced out by the risk that the market is running away from you and the potential for you to sustain market impact."
Buy-side traders acknowledge that the current volatility adds risk to trading large blocks in traditional crossing networks. "With the volatility in these markets, you're better off picking your spots, rather than just putting up the stock at one price," comments Andrew Weinberg, a trader with Dallas-based Brazos Capital, an asset management firm that specializes in small-, micro- and mid-cap stocks.
End of the Block?
Of course institutions still have huge orders to move. "We're not seeing the demise of the block trade," notes Weinberg. "I just think we're in different times now than ever experienced. I think the [trading] style changes."
Weinberg explains that he uses Liquidnet for block crossing, but also taps into OnePipe, an aggregator that reaches out to more than 30 dark pools, as well as Knight Direct's dark liquidity algorithm. "Personally, I think that block trading is risky in this type of volatile market," he says.
"I wouldn't say we're seeing the demise of the blocks," adds Larry Tabb, cofounder and CEO of TABB Group. "There are still blocks, but what we're seeing is a reduction in usage of blocks."
"A fair amount of blocks were done with capital [commitment], and capital is becoming more expensive for the banks and they don't want to take the risk," Tabb explains. "Second, because of intraday volatility, people are wary of putting up a block unless they have some sort of confidence in the short-term direction of the market. And third, the continued increase in algorithmic flow makes finding blocks harder as they are just being broken up in smaller pieces."
Regardless of the volatility, however, asset managers value the block crossing networks because they can match anonymously in these pools with natural contra-side counterparties, contends Vlad Khandros, an executive with Liquidnet's corporate strategy group. "There is a strong desire to execute blocks without moving the market," he says, noting that Liquidnet continues to see demand from institutions to execute 200,000-share and larger orders. "That hasn't changed. What has changed is the ability to source the liquidity. It has become a challenge for the large asset managers to source enough liquidity in the market to meet their demand."
While Khandros concedes that volatility has exacerbated the liquidity challenge, he points out that the typical trade size in Liquidnet is still 55,000 shares. "That's pretty good evidence that the size of those blocks is not changing," says Khandros, who adds that in 2008 Liquidnet executed more than 300 block trades of 1 million shares or more.
To address the scarcity of liquidity, says Rosenblatt's Schack, the block crossing networks have realized that they need to interact with the continuous, displayed markets and algorithmic, retail-size flow. In fact, on top of the 2.5 billion shares resting in its institutional pool, Liquidnet's H20 product, which interacts with liquidity providers from more than two dozen venues, including the NYSE and BATS Trading, now brings in 9 billion shares of liquidity daily, about one-third of Liquidnet's total volume, according to Khandros.
Through its Supernatural order type, Liquidnet gives members the ability to interact with one another while sourcing liquidity through H20 or an outside venue, Khandros explains. "What institutions are doing is creating an order in Supernatural and interacting with the streaming flow coming in, while waiting for that large, natural contra," he relates. "The execution happens at the midpoint of the spread and is completely automated and anonymous, with no interaction and market impact and little to no information leakage."
Similarly, Pipeline has launched its Algorithm Switching Engine, which allows buy-side firms to search for additional liquidity via third-party algorithms.
Meanwhile some question the wisdom of using algorithms at all amid super-volatile markets. "It's my opinion that algorithms are broken," says Federated's Setzenfand. "An algorithm is usually based on historical performance of a stock, and if that performance goes off the charts, that traditional algorithm isn't going to perform how it's performed historically," she warns.
Push to Sales Traders
It is precisely for this reason that the buy side increasingly is turning to sales traders at brokerage firms for help, according to TABB Group's Tabb, who notes that the sell-side sales traders are equipped with the same tools that buy-side traders leverage. "They're looking in dark pools, they're using algorithms and DMA tools, and using the FIX [protocol] to find the other side of the trade," he explains.
Federated's Setzenfand agrees that buy-side firms are tapping the expertise of the sell side for a portion of their block trades. "You've got the relationship and the second set of eyes," she notes. "You're searching for traditional blocks and for dark blocks."
This trend also is contributing to the decline in market share of the independent block crossing networks, most experts agree. Last year broker- and market maker-owned dark pools whose average execution sizes are in the 250-to-500-share range increased their volume at the expense of the more traditional block crossing networks, according to market structure analysis from Rosenblatt Securities (see sidebar: "Broker-Owned Dark Pools Grab Market Share").
However, these cheap, fast, algo-friendly dark pools are not block-oriented as most of the orders they receive already have been sliced and diced. In addition, buy-side firms are reluctant to leave resting orders in sell-side pools or pools that interact with aggregators that may execute in pools that send out IOIs for fear of information leakage. But these dark pools are aspiring to make the buy side more comfortable with placing blocks in their dark pools, and some of the broker-owned dark pools are courting block orders.
For example, a new block trading facility, known as New York Block Exchange, or NYBX, was launched in February by the New York Stock Exchange (NYSE) that links BIDS' dark liquidity to the NYSE's public, reserve and hidden order books as a way to aggregate block trades. And recently Goldman Sachs' Sigma X began offering a point-in-time crossing service called Sigma X-Cross, and also plans to unveil a block alert service that notifies participants of the presence of a large order. In addition, LeveL ATS, a consortium-owned dark pool, is working on a block order type that will encourage the buy side to submit larger orders by putting a trigger price or maximum quantity on the order.
Many buy-side traders suspect that sales traders are being instructed to search for matches in their own internal dark pools before going out to other venues, which is leading to a boost in volume in broker-owned dark pools. "It would be natural that the crossing in their own individual pools would go up," comments Lisa Utasi, senior trader and director at ClearBridge Advisors in New York. "They don't just work the order; they throw it in their own algos."
But Brazos Capital's Weinberg isn't sold on the sales trader's advantage. "When handling a block situation, this is where the relationship is key. You must know whom you are giving this information to," cautions Weinberg, who adds that the buy-side trader will parse out an order or provide an indication of interest (IOI) to a broker. But, "If speed is most important for a specific order, I think you are best to go in a dark pool or aggregator," he says, noting that he prefers to use an aggregator that leverages smart technology to ping the most venues and has security measures in place to prevent information leakage.
"The whole market is shifting around," says TABB Group's Tabb, who notes that as buy-side firms experience a decline in assets under management and fee income, and lay off traders, they are outsourcing flow to sales traders. "The buy side is counting on the relationships they have with the sales traders to do the right thing. ... Large brokers are out of it, and smaller brokers are seeing more flow," he relates. "As for blocks, blocks are going to the smaller firms, but they tend to be small- and mid-cap names. The more liquid stocks are still going to the larger folks and are more algo-driven."
Long Live the Block Crossing Network
Despite all the volatility and uncertainty, evidence suggests that the advantages of electronic block crossing still appeal to buy-side traders because they can operate anonymously, seek a natural counterparty, minimize information leakage and reduce their chances of moving the market. In fact a December TABB Group report showed that usage of electronic crossing networks is increasing for those blocks that institutions are looking to trade. Large asset managers execute slightly more than half (53 percent) of their blocks electronically through traditional block crossing networks, according to the firm's institutional equity trading report. Tabb says that number is likely to increase to 64 percent by 2010.
And if the volatility subsides, buy-side traders may rely on crossing networks even more, notes Brazos Capital's Weinberg. But right now, he points out, they are coping with exaggerated intraday price swings, "So you're better off stretching out the order," Weinberg adds.
In the end it comes down to the skill and experience of the buy-side trader. "That's where the buy-side trader comes in. With experience, they can understand the markets and pick the right spots," says Weinberg. "We're seeing a time that no one has ever seen before. With this type of volatility, you have to be aware of what's going on in the marketplace and in those individual names before you just throw the block up."
Volatility Shakes Up Block Trading
By Ivy Schmerken
Feb 26, 2009
URL: http://www.advancedtrading.com/showArticle.jhtml?articleID=214600317
When Treasury Secretary Timothy Geithner unveiled his highly anticipated bank bailout plan Feb. 10, traders panned the strategy for a lack of details, causing the Dow to plummet nearly 382 points that day. That kind of reaction has made buy-side institutions skittish about leaving block trades waiting in traditional block crossing networks.
With uncertainty over the U.S. economy and volatility causing erratic intraday price swings in the stock market, buy-side traders say they are seeking fewer block trades while also finding it harder to execute blocks in traditional crossing networks. According to TABB Group estimates, block trading now accounts for 8 percent of total U.S. equity trading volume, down from 17 percent in 2006, which factors in retail, institutional, proprietary and principal-based flows.
"It's gotten harder to execute blocks in general," says Jennifer Setzenfand, a VP and senior trader at Federated Investors in Pitt*****urgh. Setzenfand, who utilizes institutional crossing network Liquidnet, says less than 10 percent of Federated's order flow comprises blocks.
Instead institutions are breaking up more orders and leveraging algorithms to work them throughout the day, traders say. At the same time, there also has been a shift to high-speed venues. In turn, however, this is making it even harder to execute blocks.
Fear Factor: Changes in Traders' Behavior
According to Setzenfand, volatility has changed the behavior of buy-side traders. On one hand, they fear they might get adverse prices if they place standing block orders in a dark pool, where they may need to wait for several hours to find a counterparty, she relates. On the other hand, "If I'm a buyer and the market is going down, I don't want to buy it early because it's going to be cheaper later on," Setzenfand adds. "If I put [a block] in a dark pool, I stand the chance of it all getting done, so I don't want to put it in a dark pool."
Until the volatility subsides, institutions will be leery of doing block trades, suggests a buy-side trader at a public retirement system in the Southwest who requested anonymity. "Because of this volatility, you don't want to be explaining why you bought stock and got the worst price of the day," says the trader, who uses traditional block crossing systems Liquidnet and Pipeline. "I'm still doing some block trading at certain price points on certain stocks, but overall probably less."
When determining how to trade a block-size order, Federated's Setzenfand continues, it depends on the direction of the market. "It's really about traders making directional calls on the stock and the sector and the market, and then deciding how to execute from there," she explains. "If something is coming my way, and I'm buying into the market and the stock is going down, I'm going to do small trades little by little, either the traditional way through a broker or using an algo to slice it."
So as volatility becomes the norm, traders want more immediacy with their executions and have begun to shift order flow to high-speed venues to mitigate uncertainty. According to TABB Group estimates, 70 percent of current trading volume is sent through direct-market-access (DMA) platforms or utilizes algorithms and black-box trading strategies.
"The traditional assumption is that volatility is generally not a good thing for block crossing network volumes," comments Justin Schack, VP, market structure, at Rosenblatt Securities in New York. "If the market is moving really fast, the benefit of waiting for a block counterparty to show up is balanced out by the risk that the market is running away from you and the potential for you to sustain market impact."
Buy-side traders acknowledge that the current volatility adds risk to trading large blocks in traditional crossing networks. "With the volatility in these markets, you're better off picking your spots, rather than just putting up the stock at one price," comments Andrew Weinberg, a trader with Dallas-based Brazos Capital, an asset management firm that specializes in small-, micro- and mid-cap stocks.
End of the Block?
Of course institutions still have huge orders to move. "We're not seeing the demise of the block trade," notes Weinberg. "I just think we're in different times now than ever experienced. I think the [trading] style changes."
Weinberg explains that he uses Liquidnet for block crossing, but also taps into OnePipe, an aggregator that reaches out to more than 30 dark pools, as well as Knight Direct's dark liquidity algorithm. "Personally, I think that block trading is risky in this type of volatile market," he says.
"I wouldn't say we're seeing the demise of the blocks," adds Larry Tabb, cofounder and CEO of TABB Group. "There are still blocks, but what we're seeing is a reduction in usage of blocks."
"A fair amount of blocks were done with capital [commitment], and capital is becoming more expensive for the banks and they don't want to take the risk," Tabb explains. "Second, because of intraday volatility, people are wary of putting up a block unless they have some sort of confidence in the short-term direction of the market. And third, the continued increase in algorithmic flow makes finding blocks harder as they are just being broken up in smaller pieces."
Regardless of the volatility, however, asset managers value the block crossing networks because they can match anonymously in these pools with natural contra-side counterparties, contends Vlad Khandros, an executive with Liquidnet's corporate strategy group. "There is a strong desire to execute blocks without moving the market," he says, noting that Liquidnet continues to see demand from institutions to execute 200,000-share and larger orders. "That hasn't changed. What has changed is the ability to source the liquidity. It has become a challenge for the large asset managers to source enough liquidity in the market to meet their demand."
While Khandros concedes that volatility has exacerbated the liquidity challenge, he points out that the typical trade size in Liquidnet is still 55,000 shares. "That's pretty good evidence that the size of those blocks is not changing," says Khandros, who adds that in 2008 Liquidnet executed more than 300 block trades of 1 million shares or more.
To address the scarcity of liquidity, says Rosenblatt's Schack, the block crossing networks have realized that they need to interact with the continuous, displayed markets and algorithmic, retail-size flow. In fact, on top of the 2.5 billion shares resting in its institutional pool, Liquidnet's H20 product, which interacts with liquidity providers from more than two dozen venues, including the NYSE and BATS Trading, now brings in 9 billion shares of liquidity daily, about one-third of Liquidnet's total volume, according to Khandros.
Through its Supernatural order type, Liquidnet gives members the ability to interact with one another while sourcing liquidity through H20 or an outside venue, Khandros explains. "What institutions are doing is creating an order in Supernatural and interacting with the streaming flow coming in, while waiting for that large, natural contra," he relates. "The execution happens at the midpoint of the spread and is completely automated and anonymous, with no interaction and market impact and little to no information leakage."
Similarly, Pipeline has launched its Algorithm Switching Engine, which allows buy-side firms to search for additional liquidity via third-party algorithms.
Meanwhile some question the wisdom of using algorithms at all amid super-volatile markets. "It's my opinion that algorithms are broken," says Federated's Setzenfand. "An algorithm is usually based on historical performance of a stock, and if that performance goes off the charts, that traditional algorithm isn't going to perform how it's performed historically," she warns.
Push to Sales Traders
It is precisely for this reason that the buy side increasingly is turning to sales traders at brokerage firms for help, according to TABB Group's Tabb, who notes that the sell-side sales traders are equipped with the same tools that buy-side traders leverage. "They're looking in dark pools, they're using algorithms and DMA tools, and using the FIX [protocol] to find the other side of the trade," he explains.
Federated's Setzenfand agrees that buy-side firms are tapping the expertise of the sell side for a portion of their block trades. "You've got the relationship and the second set of eyes," she notes. "You're searching for traditional blocks and for dark blocks."
This trend also is contributing to the decline in market share of the independent block crossing networks, most experts agree. Last year broker- and market maker-owned dark pools whose average execution sizes are in the 250-to-500-share range increased their volume at the expense of the more traditional block crossing networks, according to market structure analysis from Rosenblatt Securities (see sidebar: "Broker-Owned Dark Pools Grab Market Share").
However, these cheap, fast, algo-friendly dark pools are not block-oriented as most of the orders they receive already have been sliced and diced. In addition, buy-side firms are reluctant to leave resting orders in sell-side pools or pools that interact with aggregators that may execute in pools that send out IOIs for fear of information leakage. But these dark pools are aspiring to make the buy side more comfortable with placing blocks in their dark pools, and some of the broker-owned dark pools are courting block orders.
For example, a new block trading facility, known as New York Block Exchange, or NYBX, was launched in February by the New York Stock Exchange (NYSE) that links BIDS' dark liquidity to the NYSE's public, reserve and hidden order books as a way to aggregate block trades. And recently Goldman Sachs' Sigma X began offering a point-in-time crossing service called Sigma X-Cross, and also plans to unveil a block alert service that notifies participants of the presence of a large order. In addition, LeveL ATS, a consortium-owned dark pool, is working on a block order type that will encourage the buy side to submit larger orders by putting a trigger price or maximum quantity on the order.
Many buy-side traders suspect that sales traders are being instructed to search for matches in their own internal dark pools before going out to other venues, which is leading to a boost in volume in broker-owned dark pools. "It would be natural that the crossing in their own individual pools would go up," comments Lisa Utasi, senior trader and director at ClearBridge Advisors in New York. "They don't just work the order; they throw it in their own algos."
But Brazos Capital's Weinberg isn't sold on the sales trader's advantage. "When handling a block situation, this is where the relationship is key. You must know whom you are giving this information to," cautions Weinberg, who adds that the buy-side trader will parse out an order or provide an indication of interest (IOI) to a broker. But, "If speed is most important for a specific order, I think you are best to go in a dark pool or aggregator," he says, noting that he prefers to use an aggregator that leverages smart technology to ping the most venues and has security measures in place to prevent information leakage.
"The whole market is shifting around," says TABB Group's Tabb, who notes that as buy-side firms experience a decline in assets under management and fee income, and lay off traders, they are outsourcing flow to sales traders. "The buy side is counting on the relationships they have with the sales traders to do the right thing. ... Large brokers are out of it, and smaller brokers are seeing more flow," he relates. "As for blocks, blocks are going to the smaller firms, but they tend to be small- and mid-cap names. The more liquid stocks are still going to the larger folks and are more algo-driven."
Long Live the Block Crossing Network
Despite all the volatility and uncertainty, evidence suggests that the advantages of electronic block crossing still appeal to buy-side traders because they can operate anonymously, seek a natural counterparty, minimize information leakage and reduce their chances of moving the market. In fact a December TABB Group report showed that usage of electronic crossing networks is increasing for those blocks that institutions are looking to trade. Large asset managers execute slightly more than half (53 percent) of their blocks electronically through traditional block crossing networks, according to the firm's institutional equity trading report. Tabb says that number is likely to increase to 64 percent by 2010.
And if the volatility subsides, buy-side traders may rely on crossing networks even more, notes Brazos Capital's Weinberg. But right now, he points out, they are coping with exaggerated intraday price swings, "So you're better off stretching out the order," Weinberg adds.
In the end it comes down to the skill and experience of the buy-side trader. "That's where the buy-side trader comes in. With experience, they can understand the markets and pick the right spots," says Weinberg. "We're seeing a time that no one has ever seen before. With this type of volatility, you have to be aware of what's going on in the marketplace and in those individual names before you just throw the block up."
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