CME Study Claims HFT Reduces Price Swings

Original Story

Phantom Indexes

If so much volume trades off-primary – how valid are our index values??? Good food for thought.

Smart Order Routing: Multi Agent System for Real Time Adaptive SOR in Dark Pools

More SOR Reading

There are several papers (and authors) that are referenced again and again in the algorithmic trading literature. 1st – the ‘mother’ of most papers in algo trading:

• Robert Almgren and Neil Chriss. Optimal execution of portfolio transactions. J. Risk, 3(2):5–39, 2000.

This paper in particular is referenced by just about *every* paper on algorithmic trading. In this paper the generalized model for arrival price algorithms is related to the reader. This paper itself also does reference an earlier and oft referenced paper worth mentioning:

• Bertsimas and Lo (1998). Optimal control of liquidation costs. J. Financial Markets

The second most important paper referenced constantly is:

• Optimal Trading Strategy and Supply/Demand Dynamics Anna Obizhaeva and Jiang Wang

This paper is also fantastic, referencing the work of Almgren and Chriss and talking more about limit order books and such.

Next there are several worth getting to – listed in my preferred order:

• Bayesian Adaptive Trading with a Daily Cycle Robert Almgren? and Julian Lorenz
• Understanding the Profit and Loss Distribution of Trading Algorithms Robert Kissell 2005
• The Expanded Implementation Shortfall: “Understanding Transaction Cost Components” Robert Kissell May 2006

There are dozens more, and I would point the interested reader to these ‘less than seminal’ yet educational papers in the area of algo trading:

• Statistical properties of stock order books: empirical results and models Jean-Philippe Bouchaud, Marc M ?ezard, Marc Potters February 6, 2008
• Order Aggressiveness in Limit Order Book Markets Angelo Ranaldo* UBS Global Asset Management
• Optimal Trading in a Dynamic Market Robert Almgren? June 30, 2009
• Optimal Execution with Nonlinear Impact Functions and Trading-Enhanced Risk Robert F. Almgren? October 2001
• Optimal execution strategies in limit order books with general shape functions Aur ?elien Alfonsi?, Alexander Schied? 2007
• Algorithmic Trade Execution and Market Impact Richard Coggins†, Marcus Lim‡, Kevin Lo 2006

I have been reading, re-reading and re-reading these (and more) over and over – all great stuff for anyone interested in algo trading.

I have been reading a few books that are related:

• Empirical Market Microstructure
• An Introduction to High Frequency Finance

This paper gives a pretty good overview and meaningful conclusions from the space…

Characterization of Financial Time Series

This month’s Futures and Options Trader has an article this month about what they call “gamma scalping”. I have heard this name before, and I never connected it to the thing they are talking about in this article. Essentially – if you are buying options, you have a view on vol, if you are delta hedging, and right about vol – you want big gamma, so you can continually buy low/ sell high.

I have talked about this with a few people lately, I figured posting a pointer to the article would be nice

-Chris

I was speaking with a few colleagues this week about dispersion trading. I though I had a basic understanding of what a dispersion trade was, but as we talked about it – I said to myself; it seems just like stat arb for volatility.

So, this weekend, as Gabe is sitting next to me playing his Legend of Zelda; I found this article @ Risk Latte. It says essentially what i thought – and even calls dispersion trading “volatility arbitrage”. I will not re-explain what the article says infinitely better than I could, but I thought it was interesting how simply connecting a concept you know to something you vaguely understand solidifies the understanding.

It is amazing how much I know that I do not know

-Chris

I am reading an interesting and timely book on the current credit crisis; The Trillion Dollar Meltdown. I will update with my thoughts on the book when I am done with it, but I wanted to comment on 1 particular element presently…

There have been several theories on why the 1987 crash happened, but it seems that at least 2 books agree that it was due to ‘everybody using Portfolio Insurance’. The other book was Bookstabber’s Demons of our Own Design (which I quite enjoyed). Essentially, some smart folks came up with portfolio insurance. It worked well for them, they started selling it as a service to other firms. Soon enough, everybody was doing it. When the portfolios started hitting their floors, there was a fantastic circular reaction between markets that were now interconnected via portfolio insurance programs all over the street. Downward spiral ensues. Money disappears, etc.

I just thought it was noteworthy that this is the 2nd book that said outright that the basic issue was primarily portfolio insurance.

-Chris

PS – I am wondering if CPPI (zero coupon bonds usually involved) vs the futures technique referred to in the case of the ‘87 crash are the same? Is CPPI an evolution of that portfolio insurance? Always more to learn.

IVolatility’s March Trading Digest had an interesting commentary on the impact that the dying USD should have on commodities.

Go read this article. I will sum up, and not reiterate the world – essentially their point in the beginning of the article is that the falling dollar will most likely drive up the cost of commods that are priced in USD (duh) – inflation. From a trading perspective – this means get long commods. As I mentioned yesterday, generally being short the USD, given the US fiscal policy (to ’save us’ from the impending economic issues) seems wise as well.

So – we have inflation adjusted treasuries, short the dollar in (via whatever instruments you choose), long volatility via the VIX futures or options, long commodities however you choose. All of this seems sound at the core. It seems that the US stock market will likely go down, but the rest of these decisions seem significantly more likely to be the way that it will go.

The next question – given the above theoretical portfolio – how do we diversify and take on some soft of hedge-ish positions so that if we are wrong, we are not screwed… How do we do this in such a way that we do not set ourselves up to spend all our earnings paying out the hedges…

More food for thought;
Chris

Intrade Prediction Markets- This is just amazing. You can actually get long Obama, Short McCain, Long Recession, etc. Prediction Markets are amazing.

Several others in blogland are ref’ing this – but it is excellent – so I will too:

Survey data from SIFMA

There are just tons of interesting stats on electronic trading, multi-asset trading, etc. My favorite excerpt: