The Anatomy of Trading Algorithms

45 Pages Posted: 18 Dec 2019 Last revised: 15 May 2020

See all articles by Tyler Beason

Tyler Beason

Arizona State University (ASU) - Finance Department

Sunil Wahal

Arizona State University (ASU) - Finance Department

Date Written: May 14, 2020

Abstract

We study the anatomy of four widely used standardized institutional trading algorithms representing $675 billion in demand from 961 institutions between 2012 and 2016. The central tradeoff in these algorithms is between the desire to trade and incurring transaction costs. Large parent orders generate hundreds of child orders which strategically employ price, time, and display priority rules to navigate this tradeoff. Price impact occurs both at the time an order is submitted to the book (regardless of whether it is filled), and at the time of execution. Passive child orders have much lower likelihood of execution but still incur substantial price impact. Conversely, marketable orders, even though immediately executable, do not necessarily guarantee execution and generate even larger price impact. The distribution of child orders is non-random, generating strategic runs which oscillate between providing and taking liquidity.

Keywords: Institutional Trading, Trading Algorithms, Market Microstructure, Transaction Costs

JEL Classification: G12, G23

Suggested Citation

Beason, Tyler and Wahal, Sunil, The Anatomy of Trading Algorithms (May 14, 2020). Available at SSRN: https://ssrn.com/abstract=3497001 or http://dx.doi.org/10.2139/ssrn.3497001

Tyler Beason

Arizona State University (ASU) - Finance Department ( email )

W. P. Carey School of Business
PO Box 873906
Tempe, AZ 85287-3906
United States

HOME PAGE: http://tbeason.com

Sunil Wahal (Contact Author)

Arizona State University (ASU) - Finance Department ( email )

W. P. Carey School of Business
PO Box 873906
Tempe, AZ 85287-3906
United States

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