The Anatomy of Trading Algorithms
45 Pages Posted: 18 Dec 2019 Last revised: 15 May 2020
Date Written: May 14, 2020
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: Suggested Citation