Aite Group, a Boston research firm, reports that the high frequency trading community is now responsible for more than 60% of average daily volume in U.S. equities. High frequency trades are often executed with automated systems. Data volumes are exploding on Wall Street and the number of trades executed each year is increasing significantly. Traders and buy-side firms need technology to handle this fast-paced market. But what is automated trading and how does the human trader fit into the picture? At first glance, the word “automated” seems to eliminate the need for smart human traders and compel conformity in trading strategies. After all, if high-powered computers are doing everything and finding the perfect formulas, then what’s the use of even the best quant?
In reality, “automated” trading works very differently from this scenario. In fact, automated trading platforms give human buy-side traders more control over trading strategy and execution and allow them to adjust to the changing market in real time. To understand how this works in practice, let’s take a quick trip back to the time when the buy-side started adopting automated trading systems over a decade ago.
Before the age of automation, there was a distinct separation between the activities of the buy-side and the sell-side in the financial services world. The buy-side gave trading instructions to the sell-side and waited for the sell-side to execute these instructions in capital markets. This was a slow process. By the time the sell-side firms executed trades, the circumstances in the market may have changed to the point that the original instructions were no longer desirable from the perspective of the buy-side. As trading volumes exploded, this paradigm was no longer sustainable.
To cure the ills of a slow, disjointed trading process, the buy-side started to adopt technology. What if buy-side traders could not only develop sophisticated strategies for trading, but also automate the process of performing those strategies by themselves? With the help of technology, the buy-side could determine what to trade and when to trade it. With the help of technology, traders could have direct market access and turn quantitative models in their heads into real time executions. Since hedge funds deal with particularly complex strategies, they led the charge in automation. This put pressure on other asset managers to keep pace and a technology race ensued.
Today, many buy-side firms and traders work closely with automated trading technology to couple greater control with super fast execution and analysis. Qualitative traders use future-looking announcements from companies and quantitative traders use historical and statistical data to create models and mathematical algorithms for deciding what to trade and the opportune moment to trade. With automated trading systems, both types of traders can launch these models via the technology, tweak them as new data becomes available, and execute trades immediately. This means direct market access. No unnecessary, costly delays. The trader drives the system, but the system is powerful enough to act effectively upon the trader’s vision.
Are there any potential risks to this approach? Sure, markets are complex and the automated system may encounter events which the trader had not considered, but this risk can be mitigated by a flexible system that allows the trader to intervene easily. At Marketcetera, we built our automated trading platform with this issue in mind. Average traders and large buy-side firms alike can benefit from an open source platform that is easily accessible and moldable to specific requirements in real time. The human factor is still critical in the trading world, and humans require freedom and control to maximize success in the market.