Seven Months After The Crash

Dow Jones Index Drop

Dow Jones Index Drop

The September 2008 market crash has certainly shaken up the trading industry.

For buy-side firms and hedge funds in particular, the volatile period over the last seven months has required difficult adjustments. The realities of a new market have challenged the assumptions inherent in hedging practices and federal regulations (such as the short selling ban) have forced firms to radically change how they do business – from trading strategy to cost structures to IT systems. What have we learned?

Emerging from the past seven months, we know that the rules have changed as a result of the market collapse. Firms large and small are finding that the right technology provides opportunities for keeping up.

Before the crash, when everyone was making money, firms didn’t have to count every penny invested in technology and trading systems, as long as there was the hope that they would gain an edge in the market. But in recent months, firms have had to take a hard look at their costs. Every expenditure needs to be justified, and every piece of technology needs to prove its value. When the government changes the rules on you and bans short selling two hours before a market close on an expiration Friday, your trading system better be agile enough to immediately modify your strategy or you’ll lose millions.  No one can afford a months-long implementation cycle – the rules can change at any moment again.

Hedge funds have had to weather the market collapse and ensure compliance with new regulations by analyzing and adjusting order management processes, temporarily shutting down trading systems, and rethinking algorithms and strategies. With lighter staff and budgets, the task of reinventing the wheel was daunting and people lost a lot of money in the process.

Remember the Y2K scramble to fix everything at once? Now throw a recession into the mix. Hedge funds took on the massive responsibility of converting their systems at the time they were hurting the most.  In addition, as prime brokers collapsed or teetered on the brink, hedge funds became much less willing to put all of their eggs in one basket. As a result, “mini-primes” emerged as the new thing. Connecting to multiple brokers at once necessitated a move to broker neutral trading systems.  Nobody wants to be locked in to BearTrade when the broker behind it disappears overnight.

In this time, what hasn’t changed is the need for high-volume automated trading. While the Dow has plummeted, volatility has actually increased. Shares per trade may be down, but the absolute volume of trades is continuously increasing in accordance with historical trends. Automated trading will continue to have an important place in buy-side firms, but the nature of the platform will determine their ability to cope with the new market.

As the market takes new shape, hedge funds no longer have the luxury to invest heavily in inflexible proprietary systems, nor do they have the time or resources to build custom trading systems themselves. As a result, we are noticing that quite a few firms, including very large established institutions, are taking a much deeper look at open source in order to manage cost and control and tailor strategies to an ever-changing market and regulatory environment.

Historically, severe market changes have often bred new technologies and business processes. The dot-com crash brought Linux and open source on Wall Street, and we firmly believe that this market crash will propel open source even further into the front and backoffice systems on Wall Street.

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