Aggressive long-term traders can harm dark pool executions
Buy-side market participants should be aware that not
all longer-term trading strategies are benign and that executing against them may
be detrimental, according to a new study by Credit Suisse.
The research, titled ‘Classifying dark counterparties’,
uses the Swiss bank’s Alpha Scorecard tool, which quantitatively measures dark
pool interactions on the firm’s Crossfinder dark pool, to examine the impact of interacting with different types of trading flow.
When the researchers looked for opportunistic trading
behaviour, the Alpha Scorecard methodology highlighted some longer-term trading
flow for its oversized and overly-aggressive manner. These strategies traded in
dark pools on the way to taking out several price levels on displayed order
books, causing the stock price to move adversely.
Alpha Scorecard divides counterparties into one of
three groups – contributory, neutral or opportunistic – based on whether a
counterparty bought at a low price and sold at a high price (contributory) or
the reverse (opportunistic). The Credit Suisse methodology analyses trading behaviour visible consistently across a large number of dark fills. When analysing each dark fill, the team used average spread and intraday volatility to create a stock-specific timeframe to ensure the results were accurate and relevant.
Opportunistic counterparties are identified in
Crossfinder and are unable to choose their counterparties, whereas those
identified as contributory or neutral are allowed to choose – effectively
allowing those market participants that are deemed ‘responsible’ to avoid those
that are not.
According to the Alpha Scorecard, opportunistic
activity can sometimes account for as much as 10% of flow in a dark pool,
although it does point out that the figure is normally closer to 5%. The paper
also warns that aggregated flow can mask undesired behaviour, making it more
difficult to identify opportunistic flow.
Following the introduction of the Alpha Scorecard,
Credit Suisse has reported that Crossfinder now accounts for just over 15% of
the firm’s European flow in Q2 2012, up from around 8% when the Scorecard was
introduced in Q1 2011.
Dark pools that aim to prohibit certain types of
trading flow or empower users to choose who they execute against are growing in
Europe. CA Cheuvreux recently converted its BLINK broker crossing network into
a multilateral trading facility and structure the venue to preclude
high-frequency trading, while Quote MTF announced QLX, a hybrid trading venue
that allows users to choose the counterparties they interact with. Furthermore, Turquoise and Nasdaq OMX Nordic have adjusted their dark pools to favour
trading in larger size.