Algorithms Used By Financial Institutions

Enhanced DMA strategies

  • Iceberging: Large order is partially hidden. Max shares shown used as input.
  • Pegging: Order is sent with dynamic price that changes according to market conditions.
  • Smart order routing: Liquidity is aggregated from several sources. Orders are matched to the best price and liquidity.
  • Simple time slicing: Order is split and market orders are sent at regular time intervals.
  • MOC: Order is sent into the closing auction.
Quantitative algorithms
  • VWAP: Uses standard VWAP as a benchmark and attempts to distribute large volume at the best price adjusting for volume traded in the period.
  • TWAP: Similar to VWAP but uses time instead of volume.
  • Participate [Inline, Follow, With Volume, POV]: Trades volume using a fraction as input.
  • MOC: Enhanced MOC with optimized risk and impact.
  • Implementation Shortfall (Execution Shortfall, Arrival Price): Manages the trade off between impact and risk to execute trades as close as possible to a target midpoint .
– A buy-side handbook Algorithmic Trading

Financial Models

The aim of financial models

  • Models are used to rank securities by value
  • Models are used to interpolate from liquid prices to illiquid ones
  • Models transform intuitive linear quantities into nonlinear dollar values

The right way to use models

  • Avoid too much axiomatization
  • Good models are vulgar in a sophisticated way
  • Start with a model and overlay it with common sense and experience
  • Know what’s assumed and what has been removed
  • Think of models as Gedanken Experiments
  • Beware of idolatry
It takes intuition to discover theories. Intuition may sound casual but it results from intimate knowledge acquired by careful observation and painstaking effort.
When you struggle with a field of inquiry for a long time and you eventually master and incorporate not only its formalism but its content,, you can make use of it to build things one level higher.
Intuition is a merging of the understander with the understood. It is the deepest kind of knowledge.
– Excerpt taken from “Metaphors, Models & Theories” by Emanuel Derman