Automated Trading

Automated (or Algorithmic) trading refers to computer systems that trade financial instruments without any human intervention. New automated trading systems are changing both the face and the infrastructure within investment banks. Vendors and banks are now exposing more of their systems to programmatic trading opportunities as their e-commerce offerings mature.

Over the next ten years, these changes will continue to evolve and create radical changes in the investment banks. This article explains the software reality of the new trading systems and the profound effects they will have on the banking infrastructure.

Automated trading has been around for well over 15 years in the equities market. In that time open outcry trading floors have gradually been replaced by automated exchanges. The original and still major share of automated trading is in the equity markets. Equity trading was amenable to automated trading because the market was centred on the exchanges. Automated equity trading now accounts for 20-25% of all trading in these markets. Because the FX, Money and Bond markets trade OTC (Over the Counter) they are not centralised (i.e. exchange based), it has meant waiting longer for automated trading to be enabled.

Last year saw the close of the last open-outcry trading floor in the City of London – (the International Petroleum Exchange) – which has since re-camped, on smaller scale, in Dublin. The previous ten years have seen the gradual replacement of manual-exchanges (open-outcry) floors with software exchanges in the equity, futures and options markets. Over past 15 years over the counter trading in the FX, Money and Bond Markets has also moved from phone to on-line trading. The in-house trading floors in banks have, until recently, been relatively unaffected by the drift from phone trading – as traders have simply moved from phone trading to on-screen trading. Automated trading has been restricted to the equity markets with other trading done thru phone calls and vendors on-screen trading systems.

In the past few years vendors have begun to expose their software interfaces for instruments (e.g. FX, Money and Bond Markets) that were previously hidden behind these on-line trading screens. This has enabled the potential for blanket market coverage of automated trading across most of the “primary” markets. Financial institutions are now facing the challenge that other financial institutions will gain a competitive advantage by exploiting these new trading opportunities to their disadvantage. The problem for these institutions is that it is not clear how these new automated markets will pan out.

The origins of automated trading started with the Vendors who offered prices quotations from other traders on the exchange floors and other trading floors. Originally these prices were indicative (and not tradable) but under competitive pressure vendors were allowed to publish tradable prices. Once tradable prices were available in the vendors quotation screens, vendors extended their service to allow traders to execute those prices. Finally vendors enabled automated trading by exposing their software.

In the past couple of years vendors, such as Reuters, EBS and Bloomburg are now offering automated trading across all the underlying instruments (e.g. equities, FX, bonds and money markets).

It is worth remembering that some trading is still done entirely by hand, such as trading of structured derivatives. In this market customers must still ring around banks for the best price because the deals are complex.

As I will explain it would be naïve to assume that the development of automated trading in these new automated markets will go the same way as the equity markets. The naive view would be to assume that 20-25% if these markets will become automated and trading will carry on as normal. I hope you will understand by the end of the article why these new automated markets will have a far greater impact than the rise of automated equity trading.