PNereyaiualsalte air-\ellare BIW AN Barry Johnson Algorithmic Trading & DMA An introduction to direct access trading strategies. By Barry Johnson ‘Copyright © 2010, Barry Johnson. All rights reserved. Published by 4Mycloma Press, London No par of this book may be reproduce, tre n'a revival system, o tans by ay mmcans, clone, mechani photocopying, recoding, or others, without writen ‘permission from the copyright holler. Permisions may he sought online vt the Do's omepage (nip algo-dna.com) by selecting "Contact then "Ohtining Permissions” ‘The copyrights forall the material taken from extemal sources belong 10 thie respective ‘owners, Perminsons must be sought rom the comesponding owners fr the reproduction of ny such mati. Any brand names oe product names sed inthis bok may be trade names, service marks, trademarks or egiseredtadcmarks of tee respective owners ‘This publications ftendd o provide elu and informative material om the subject mater covered. IF profesional advice ce other expert assistance is required, the services of & ‘competent Finacial profesional should be sought. Although every precaution hasbeen taken in the preparation of this book, dhe author and publisher assume no responsibility for any errs or omissions, The author and publisher al scam any responsiblity for any Tabi, less, oe rsh, personal or eerwis, whic is incured as a comsaquonce, drely or indie, ofthe ure and application of any of the cantnt ofthis bok. or mor infomation on tis book visit the website at wor algo-dma.com Print the United States, In memory of my mother. To my father. Algorithnie Trading & DMA Contents Preface Part! An overview of trading and markets 1 Overview Introduction Fundamentals Core execution methods Institutional rading pes. Electronic racing, ‘Algorithmic trading Types of adng algorthns The evluion of rang ago 17 Divect Access Trading ‘ioc! Marko Accs 1.9. How much are these execution methods used? 1.40 Fears and myths ‘Sala of algothmie wading ertormance of lpr racing Usefuiness of aortic trading 11 Summary 2 Market microstructure 24 Inroduction 22 Fundamentals 23. Marko structure and design “Types of markets Order pos Trading Protocols xi 24 25 26 3a 33 a4 35 36 Transparoncy ‘iter hour aed o-arkot wading Other inportant marke! dos fates ‘Trading mechanism research ‘rc formation Pee dscovery rade execution Feporng, cating and setlomant ‘Transaction cost measurement and analysis Cost measiremont ‘Anaya the conpanant of ransacton costs ‘Summary World markets Irtroduetion Asset classes Part ll Algorithmic trading and DMA strategies 4 Orders. Introduction Market orders Limit orders Optional order instructions Duration intone Contents 53 BNNNRvVsesaResgagaree a1 Algorithmic Trading & DMA 45 55 56 57 65 66 Other order types. Algorithm overview Trtroduction ategorsing algorithms, ‘Common features of algorithms ‘Agorthm parameters Impact driven algorithms “Tine Woighted Average Price (TWAP) Volume Woigited Average Prce (WAP) Percon of Volume (POV) Par tating Transaction costs Introduction ‘The investment process Presrade analysis. Price data Post irade analysis ‘orfomance analysis estado ranacton costs ‘Breaking down transaction costs “imostmont rolatod costs Trading lated costs Summary ‘Transaction costs across world markets 74 7s 78 77 738 Part 8 ea a2 aa aa 93 ‘Summary Optimal trading strategies Introduction ‘Assessing tho dificult of orders Selecting the optimal acing satoay ‘Choosing between trading aigorthms ‘Mapping artis 1 the efsent ag nor Facto allectng aot choice re Oteronroma eta sponte ‘Market conditions during the 2007-08 fnancal crisis ‘Adecisin tree fr strategy selection ‘Summary Ml Implementing trading strategies Order placement Introduction Price formation Valuation Models pice fomaion Price dscovery/Order matching ‘Continuous matching Gattbaced matching (Order placement decisions ‘Sgnalng risk Vonue chaise Order enoce er aggressiveness Market factors aftecing order placoment decisions Dealing with hidden ligucty Esimating execution probability Summary Execution tactics Introduction Designing execution tactics Soporunisictiquty- driven actos ‘Algorithm selection Contents