Algorithms are automated trading strategies that can be used to break larger buy or sell orders into smaller pieces over a specified period of time such as an hour or day. Traders at fund managers or brokers use them to mute price impact and mask their activity as they try to scoop up visible and hidden orders spread across exchanges and alternative venues such as dark pools and provide bids and offers to other investors.
A volume-weighted average price, or VWAP, strategy seeks to buy or sell stock over a certain period, weighted for the number of shares traded at different levels. A percentage-of-volume algorithm will try to account for a specified share of trading volume in a company’s stock to avoid buying or selling that moves the stock price. More aggressive and tailored algorithms exist to fine-tune trading based on market conditions such as changes in volume, volatility or the price movements of indexes.
Today’s trading is “yet another example of how the market structure plumbing is responsible for massive price distortions,” Joseph Saluzzi, co-head of equity trading at Themis Trading LLC in Chatham, New Jersey, said in an e-mail. “August 1st will be another day that will destroy investor confidence just like the May 6th flash crash” of 2010.
The SEC voted last month to require exchanges and the Financial Industry Regulatory Authority to build a single system to monitor and analyze trading activity on U.S. equity and options markets. The rule mandates a so-called consolidated audit trail to expedite surveillance across 13 equity exchanges, 10 options markets and more than 200 broker-dealers that execute stock trades away from public venues.
The effort is part of the agency’s response to the May 6, 2010, stock rout that temporarily sent the Dow down almost 1,000 points. The so-called flash crash was triggered by a mutual fund firm’s algorithmic trade that sparked the rapid selling of financial futures because it took into account volume but not price or time, according to a report released by the SEC and CFTC in October 2010.