The Anatomy of Trading Algorithms

48 Pages Posted: 18 Dec 2019 Last revised: 28 Sep 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: September 27, 2020

Abstract

We study the anatomy of four widely used institutional trading algorithms representing $675 billion in demand from 961 institutions between 2012 and 2016. Parent orders generate hundreds of child orders which strategically employ price, time-in-force, and display priority rules to navigate the tradeoff between the desire to trade and minimizing transaction costs. Child orders incur price impact at the time they are submitted to the book regardless of whether or not they are (ex post) filled, and even when passively priced relative to the prevailing quote. The intra-parent distribution of child orders is non-random, generating strategic runs which oscillate between the aggressive or passive side of the spread. Despite algorithmic attempts to reduce their influence, programmatic child-level price, time-in-force, and display choices aggregate up to parent-level trading costs borne by investors.

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 (September 27, 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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