Gone are the days when traders could associate buy or sell orders with particular people. Either we are talking about specialists on the NYSE or locals on CME or CBOT, they all had one great advantage. They sat next to institutional brokers trying to front run them. Back in those days, the number of traders involved in front running was limited to tens or hundreds on each exchange floor.
However, once trading moved from off-screen to on-screen, locals lost their competitive edge, but a new player stepped into the arena. This new player is disciplined, cold blooded and impersonal while his execution is flawless and takes a split second.
THE SKYNET OF FINANCIAL MARKETS
You guessed it! I am talking about predatory algorithmic traders. The kind of software that jumps in front of big orders, rides the price action and flattens its position in a fraction of a second.
While their position as liquidity providers is beneficial, their means of delivering it is detrimental to other market players. Also, the price discrepancy that an investor has to incur from the moment of order placement to the moment of execution and confirmation is exacerbated by front-running algorithms.
The only way an investor can outsmart these algorithms and have an almost perfect execution is by staying anonymous. Why and how can they achieve this? Private proxies can become their invisibility cloak.
GOOD AND BAD ALGOS – WHERE ARE YOU ON THE FOOD CHAIN?
Before we delve into the private proxy and anonymity issue, let us consider how many types of ‘algos’ are there. While there are the predatory ones front-running any large block trade like a crack addict, there are also a spectrum of ‘ethical algos’.
An ethical algorithm is a very simple piece of software created with the sole purpose of dicing and slicing big orders into small chunks and executing them into the market.
The lay man might think this is all you need for anonymity in financial markets. But as it was demonstrated in numerous cases, exchanges are doing a bad job at hiding investors anonymity. In addition, exchanges are actually complacent to front-runners because these traders are a gold mine for them. How? Beside their profits, front running algorithms as generating millions of round-trips a day, thus big profits for the exchange.
AVOID BEING THE PREDATORS’ BATE
The lay man will think that buying a black-box execution algorithm (one that doesn’t disclose its logic) to dice big block orders is enough for getting the best prices for his execution.
However, predatory algorithms might be fast, but they are not stupid or simple software. What do you think it happens with millions of small buy orders coming from the same place? One thing: THEY STAND OUT!
With a black block execution software you might outsmart the most simple algorithm but what happens with the rest? They will front-run your buy order and in the end this could mean tens or hundreds of thousand of dollars paid from your pocket straight into the front-runners’ pocket.
FLAWLESS EXECUTION THROUGH ANONIMITY AND PRIVATE PROXY
In order to avoid this sloppy execution investors needs to take full responsibility for their execution and to take a more active approach towards anonymity. Dicing your order is not enough, you have to create the illusion that all those small orders are sent by retail investors from remote locations.
To outsmart the predators, you have to create the illusion of being more stupid then you really are. Your orders don’t have to look like they are the result of spray and pray execution. Your orders need to look as if they are independent from one another.
A flawless, anonymous execution needs to create a spider web like of orders, different in size and geographic location. With the purpose to baffle whoever is taking the other side of the trade or, even the exchange itself. Make them unaware of your intentions within the marketplace. As every investor knows, an investment strategy is good as long as is unknown to other market participants.
This level of execution excellence can be achieved only if you, as an investor will take your trade execution anonymity seriously and will take an active approach to hiding your identity. Relying on a black-box type of execution algorithm will not help much your bottom line.
A FINAL WORD
To sum up, we have to specify that anonymity in financial markets is a requirement not for fouling other market participants, but for your investment principal best outcome. And always use anonymity for ethical reasons.
Execution algorithms and trading decision making algorithms are the future of financial markets. However, due to the unethical behavior of some market participants, you, as an investor need to take a more active approach to your anonymity.
Anonymity in financial markets is necessary not only for the safety of your strategy, but also for the flawless execution of your big-block trade orders.
The best way to achieve anonymity is to create a spider-like web of small trade orders. You can achieve this through private proxies. Remember to outsmart predators you have to look stupid.
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