Electronic Execution Services

One of the services that investment banks provide hedge and mutual funds is trade execution.  These fall under a variety of terms such as program trading, direct market access and algorithmic trading.  The services generally are automated services that are run by expensive technology.

Program trading is loosely defined as a transaction involving 15 or more securities worth at least $1 million in capital.  They are usually executed by computers but there are some that are done by traders.  A lot of program trading is involved in index arbitrage.  In this strategy, the investor finds discrepancies between the values of index futures and the stocks composing the index.  Based on the difference, the investor will short/long the futures and long/short the stocks.  The leading banks for program trading are Goldman Sachs and Morgan Stanley.

Direct market access allows fund managers to trade directly with an exchange instead of going through an intermediary such as a bank.  They do use applications created and managed by the banks but no trade is routed through a salestrader.  It gives them control over how a trade is executed.

Algorithmic trading is more popularly known as black box trading.  Here the fund manager implements a trading strategy that is executed by a computer.  The manager can set the timing, price and share amount of the order.  Investment banks give access directly to the manager or through a third party interface such as Bloomberg.  High frequency trading is when a computer program combs through market data to determine if certain preset conditions are met and initiates trades if it is.  Again, the rules come from the fund manager.  This approach has very short holding periods.  Since computers can recognize pricing patterns faster than humans, the fund gets first mover advantage.  Credit Suisse and Goldman Sachs have won numerous awards for algorithmic trading.

The advantages of these types of trading are lower commissions, privacy and speed.  Ten years ago, the pressure from new execution facilities and decimalization virtually broke the agency trading business.  The manager can compare trading performance of the program by comparing actual transaction prices against a benchmark.  There are two standard ones: volume weighted average prices (VWAP) and time weighted average prices (TWAP).