Crisis sparks reversal in electronic trading-study
NEW YORK, Dec 3 (Reuters) - The earthquake that shook markets this year drove increasingly computer-oriented investors back to more traditional trading methods, a study of U.S. equity trading has found.
TABB Group's annual U.S. Institutional Equity Trading study, published on Wednesday, found that so called buy-side asset managers -- including mutual funds, pension funds, and registered investment advisers -- reversed an aggressive trend toward electronic trading.
From January until the end of October of this year, 44 percent of buy-side trading volume on the New York Stock Exchange and the Nasdaq Stock Market was electronic, down from 51 percent last year, the study found.
Electronic trading rose during the recent bull market from 27 percent in 2005 to 44 percent in 2006. But the credit crisis and volatile sell-off this year has changed that.
"What happens is everybody gets gun shy because of a lack of confidence ... over the direction of the price," said Laurie Berke, author of the study and senior consultant at TABB Group, a U.S.-based research and consulting firm.
"In such a difficult environment that we've had this year, there was a renewed demand for any and all information that a sell-side trader could provide."
In August and September, TABB interviewed 61 head traders at firms that manage a total of $12.9 trillion and invest primarily for the long term. It found that the buy side accounts for some 35 percent of overall trading volume, down slightly due to the growth of hedge funds.
The findings suggested investors still look to traditional sell-side brokers when markets become unpredictable, even as markets go electronic and trading is measured in fractions of seconds.
The traditional broker has access to more market information and takes time to talk to institutional investors.
TABB's study classified as "electronic" trading methods the following: computerized models known as algorithms; buy-side firms' direct market access tools; and alternative trading systems that match buy and sell orders outside of formal exchanges.
The use of algorithms, which allow computers to make trading decisions, accounted for 24 percent of buy-side activity, up slightly from 22 percent last year and 21 percent in 2006.
TEMPORARY REVERSAL
The mortgage market-inspired credit crisis brought record volatility to world stock markets this year. Wall Street investment bank Bear Stearns was sold to JPMorgan Chase & Co (JPM.N), while Lehman Brothers Holdings Inc (LEHMQ.PK) sought bankruptcy protection, setting off an unprecedented drop in equities.
"This was an extraordinary year," said Berke. "In aggregate, I would expect that we'll see electronic trading resume its growth curve."
Automated trading could be declining because quant funds, which trade based on complex statistical models, are deleveraging as the overall market tumbles, said Diego Perfumo, an analyst at Equity Research Desk, a Connecticut-based advisory firm specializing in exchanges.
Sang Lee, an analyst at Boston consultancy Aite Group, which did a similar study in 2006, said the unprecedented level of volatility this year "led to a pull-back from some of the more active algo guys."
Aite's study found that algorithmic trading accounted for about 35 percent of all trading -- from the buy side, sell side, and hedge funds -- in 2006, and projected it will rise to more than 50 percent by 2010.
"Looking at this from a long-term perspective, once the market stabilizes, we expect the our projections to hold," Lee said.
TABB's wide-ranging study also found that the average size of trades on the two dominant U.S. venues was 245 shares in the first 10 months of this year, down 23 percent from 2007 and off 55 percent over the last four years.
Transactions on the NYSE were slightly smaller on average than transactions on the Nasdaq, the study found.
Since the 1990s, the size of transactions has shrunk as the number of alternative trading venues has grown. Orders are chopped into smaller pieces to avoid revealing traders' intentions to the marketplace -- and, in the recent volatility, to avoid taking a big loss if they are wrong.
According to data, so-called block trades of about 10,000 shares or more have dwindled over the last decade.
"It's very inefficient for a trader to try and break up orders in these fast markets," said Perfumo. "So you use electronic systems, which are much faster, to slice up the order for you." (Editing by Jeffrey Benkoe)
