Financial market participants

Investors There are two basic financial market participant catagories, Investor vs. ... Image File history File linksMetadata Size of this preview: 800 × 600 pixelsFull resolution (2816 × 2112 pixel, file size: 2. ... The word investor may refer to: A person who makes investments Investor AB, a Swedish investment company institutional investor corporate investor This is a disambiguation page, a list of pages that otherwise might share the same title. ...

Speculators speculation Speculation is the buying, holding, and selling of stocks, commodities, futures, currencies, collectibles, real estate, or any valuable thing to profit from fluctuations in its price as opposed to buying it for use or for income - dividends, rent etc. ... Speculation involves the buying, holding, and selling of stocks, bonds, commodities, currencies, collectibles, real estate, derivatives or any valuable financial instrument to profit from fluctuations in its price as opposed to buying it for use or for income via methods such as dividends or interest. ...

Institutional investors Insurance companies Investment banks Hedge funds Mutual funds Pension funds Private equity funds Venture capital funds Banks Credit Unions Trusts Prime Brokers An institutional investor is an investor who is an institution like a bank, insurance fund, retirement fund, or mutual fund manager. ... Insurance, in law and economics, is a form of risk management primarily used to hedge against the risk of a contingent loss. ... Investment banks help companies and governments and their agencies to raise money by issuing and selling securities in the primary market. ... A hedge fund is an investment fund charging a performance fee and typically open to only a limited range of investors. ... A mutual fund is a form of collective investments that pools money from many investors and invests their money in stocks, bonds, short-term money market instruments, and/or other securities. ... A pension is a steady income given to a person (usually after retirement). ... A private equity fund is a collaboration of funds that directs a private companys or individuals equity, either in the stock market or in real estate. ... Venture capital is a general term to describe financing for startup and early stage businesses as well as businesses in turn around situations. ... “Banker” redirects here. ... A credit union is a cooperative financial institution that is owned and controlled by its members. ... A trust company has been referred to as a near-bank; while technically it differs from a bank in mandate and services offered, it also provides banking services such as chequing accounts, savings and loans, investments and credit cards. ... Prime Brokerage is a service sold by investment banks to hedge funds. ...

Finance series Financial market Participants Corporate finance Personal finance Public finance Banks and Banking Financial regulation This article does not cite any references or sources. ... In economics a financial market is a mechanism that allows people to easily buy and sell (trade) financial securities (such as stocks and bonds), commodities (such as precious metals or agricultural goods), and other fungible items of value at low transaction costs and at prices that reflect efficient markets. ... There are two basic financial market participant catagories, Investor vs. ... Corporate finance is an area of finance dealing with the financial decisions corporations make and the tools and analysis used to make these decisions. ... Personal finance is the application of the principles of finance to the monetary decisions of an individual or family unit. ... Public finance (government finance) is the field of economics that deals with budgeting the revenues and expenditures of a public sector entity, usually government. ... “Banker” redirects here. ... Financial supervision is government supervision of financial institutions by regulators. ...

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In electronic financial markets, algorithmic trading, also known as algo, automated, black-box, or robo trading, is the use of computer programs for entering trading orders with the computer algorithm deciding on certain aspects of the order such as the timing, price, or even the final quantity of the order. It is widely used by pension funds, mutual funds, and other institutional traders to divide up a large trade into several smaller trades in order to avoid market impact costs and reduce other transaction costs.^[1] It is also used by hedge funds and similar traders to make the decision to initiate orders based on information that is received electronically, before human traders are even aware of the information. Electronic trading is a mode of trading that uses information technology to bring together a buyer and a seller through electronic media to create a virtual market place. ... An order in a market such as a stock market, bond market or commodities market is an instruction from a customer to a broker to buy or sell on the exchange. ... A pension (also known as superannuation) is a retirement plan intended to provide a person with a secure income for life. ... A mutual fund is a form of collective investments that pools money from many investors and invests their money in stocks, bonds, short-term money market instruments, and/or other securities. ... In financial markets, market impact is the effect that a market participant has when it buys or sells an asset. ... In economics and related disciplines, a transaction cost is a cost incurred in making an economic exchange. ... A hedge fund is an investment fund charging a performance fee and typically open to only a limited range of investors. ...

Algorithmic trading may be used in any investment strategy, including market-making, inter-market spreading, arbitrage, or pure speculation (including trend following). The investment decision and implementation may be augmented at any stage with algorithmic support or may operate completely automatically. A market maker is a person or a firm which quotes a buy and sell price in a financial instrument or commodity hoping to make a profit on the turn or the bid/offer spread. ... In economics and finance, arbitrage is the practice of taking advantage of a price differential between two or more markets: a combination of matching deals are struck that capitalize upon the imbalance, the profit being the difference between the market prices. ... Speculation involves the buying, holding, and selling of stocks, bonds, commodities, currencies, collectibles, real estate, derivatives or any valuable financial instrument to profit from fluctuations in its price as opposed to buying it for use or for income via methods such as dividends or interest. ... Trend following is an investment strategy that takes advantage of long-term moves that play out in various markets. ...

A third of all EU and US stock trades in 2006 were driven by automatic programs, or algorithms, according to Boston-based consulting firm Aite Group LLC. By 2010, that figure will reach 50 percent, according to Aite.^[2]

In 2006 at the London Stock Exchange, over 40% of all orders were entered by algo traders, with 60% predicted for 2007. American markets and equity markets generally have a higher proportion of algo trades than other markets, and estimates for 2008 range as high as an 80% proportion in some markets. Foreign exchange markets also have active algo trading (about 25% of orders in 2006).^[3] Futures and options markets are considered to be fairly easily integrated into algorithmic trading^[4], with about 20% of options volume expected to be computer generated by 2010.^[5] Bond markets are moving toward more access to algorithmic traders.^[6] The Source by Greyworld, in the new LSE building Paternoster Square. ... The foreign exchange (currency or forex or FX) market exists wherever one currency is traded for another. ... Futures may mean: Futures contract, from the world of finance Futures exchange, in finance Futures studies, reflects on how today’s changes (or the lack thereof) become tomorrow’s reality Futures (tennis), minor professional tennis events Futures (album), a 2004 album by Jimmy Eat World Futures (journal), an international, refereed... In finance options are types of derivative contracts, including call options and put options, where the future payoffs to the buyer and seller of the contract are determined by the price of another security, such as a common stock. ... In finance, a bond is a debt security, in which the authorized issuer owes the holders a debt and is obliged to repay the principal and interest (the coupon) at a later date, termed maturity. ...

History

Computerization of the order flow in financial markets began in the early 1970s with some landmarks being the introduction of the New York Stock Exchange’s “designated order turnaround” system (DOT, and later SuperDOT) which routed orders electronically to the proper trading post to be executed manually, and the "opening automated reporting system" (OARS) which aided the specialist in determining the market clearing opening price. The New York Stock Exchange (NYSE), nicknamed the Big Board, is a New York City-based stock exchange. ... In economics, market clearing refers to either a simplifying assumption made by the new classical school that markets always go to where the quantity supplied equals the quantity demanded; or the process of getting there via price adjustment. ...

Program trading is defined by the New York Stock Exchange as an order to buy or sell 15 or more stocks valued at over $1 million total. In practice this means that all program trades are entered with the aid of a computer. In the 1980s program trading became widely used in trading between equity and futures markets. Program trading is casually defined as the use of computers in stock markets to engage in arbitrage and portfolio insurance strategies. ... This article does not cite any references or sources. ... Futures may mean: Futures contract, from the world of finance Futures exchange, in finance Futures studies, reflects on how today’s changes (or the lack thereof) become tomorrow’s reality Futures (tennis), minor professional tennis events Futures (album), a 2004 album by Jimmy Eat World Futures (journal), an international, refereed...

In stock index arbitrage a trader would buy (sell) a stock index futures contract such as the S&P 500 Index futures and sell (buy) a portfolio of up to 500 stocks at the NYSE matched against the futures trade. The program trade at the NYSE would be pre-programmed into a computer to enter the order automatically into the NYSE’s electronic order routing system at a time when the futures price and the stock index were far enough apart to make a profit. Index arbitrage is a subset of statistical arbitrage focusing on index components. ... The S&P 500 is a list of 500 US corporations, ordered by market capitalization. ...

At about the same time portfolio insurance was designed to create a synthetic put option on a stock portfolio by dynamically trading stock index futures according to a computer model based on the Black-Scholes option pricing model. Constant proportion portfolio insurance (CPPI) is a capital guarantee derivative security that embeds a dynamic trading strategy in order to provide participation to the performance of a certain underlying. ... A put option (sometimes simply called a put) is a financial contract between two parties, the buyer and the writer of the option. ... The Black-Scholes model, often simply called Black-Scholes, is a model of the varying price over time of financial instruments, and in particular stocks. ...

Both strategies, often simply lumped together as “program trading,” were blamed by many people (for example by the Brady report) for exacerbating or even starting the 1987 stock market crash. Nicholas F. Brady Bradys signature, as used on American currency Nicholas Frederick Brady (born April 11, 1930, in New York City) was United States Secretary of the Treasury under Presidents Ronald Reagan and George H. W. Bush, and is also known for articulating the Brady Plan in March 1989. ... DJIA (19 July 1987 through 19 January 1988) FTSE 100 Index (19 July 1987 through 19 January 1988) Black Monday is the name given to Monday, October 19, 1987, when the Dow Jones Industrial Average (DJIA) fell dramatically, and on which similar enormous drops occurred across the world. ...

Financial markets with fully electronic execution and similar electronic communication networks developed in the late 1980s and 1990s. In the U.S., decimalization, which change the minimum tick size from 1/16th of a dollar ($0.0625) to $0.01 per share, may have encouraged algorithmic trading as it changed the market microstructure by decreasing the market-maker’s trading advantage and reduced market liquidity. Electronic Communication Network (ECN) is a non-exchange computer network to facilitate trading of financial products, primarily equities (stocks) and currencies (aka FX / Foreign exchange market). ... Decimalization refers to any process of converting from traditional units, usually of money, to a decimal system. ... Market Microstructure is a branch of economics concerned with the functional setup of a market. ... Market liquidity is a business or economics term that refers to the ability to quickly buy or sell a particular item without causing a significant movement in the price. ...

The reduced liquidity was reflected by smaller trade sizes, which led to institutional traders splitting up orders according to computer algorithms in order to execute their orders at a better average price. These average price benchmarks are measured and calculated by computers by applying the time weighted (i.e unweighted) average price TWAP or more usually by the volume weighted average price VWAP. TWAP is a trading acronym for Time Weighted Average Price. ... VWAP is a trading acronym for Volume-Weighted Average Price, the ratio of the value traded to total volume traded over a particular time horizon (usually one day). ...

As more electronic markets opened, other algorithmic trading strategies became possible including arbitrage and statistical arbitrage. These strategies are more easily implemented by computers because machines can react more rapidly to temporary mispricing and examine prices from several markets simultaneously. In economics and finance, arbitrage is the practice of taking advantage of a price differential between two or more markets: a combination of matching deals are struck that capitalize upon the imbalance, the profit being the difference between the market prices. ... Statistical arbitrage, as opposed to (deterministic) arbitrage, is related to the statistical mispricing of one or more assets based on the expected value of these assets. ...

Strategies

Many different algorithms have been developed to implement different trading strategies. These algorithms or techniques are commonly given names such as "iceberging", "Guerrilla", "benchmarking", "Sniper" and "Snif-fer".^[7]

Transaction cost reduction

Large orders are broken down into several smaller orders and entered into the market over time. This basic strategy is called "iceberging". The success of this strategy may be measured by the average purchase price against the VWAP for the market over that time period. One algorithm designed to find hidden orders or icebergs is called "Guerrilla".

Arbitrage

A classical arbitrage strategy might involve three or four securities such as covered interest rate parity in the foreign exchange market which gives a relation between the prices of a domestic bond, a bond denominated in a foreign currency, the spot price of the currency, and the price of a forward contract on the currency. If the market prices are sufficiently different from those implied in the model to cover transactions cost then four transactions can be made to guarantee a risk-free profit. Algorithmic trading allows similar arbitrages using models of greater complexity involving much more than 4 securities. It has been suggested that this article or section be merged with Spot-future parity. ... The foreign exchange (currency or forex or FX) market exists wherever one currency is traded for another. ...

Market making

Market making involves placing a limit order to sell (or offer) above the current market price or a buy limit order (or bid) below the current price in order to benefit from the bid-ask spread. Automated Trading Desk, which was bought by Citigroup in July 2007, has been an active market maker, accounting for about 6% of total volume on both NASDAQ and the New York Stock Exchange.^[8]

More complicated strategies

A "benchmarking" algorithm is used by traders attempting to mimic an index's return. An algorithm designed to discover which markets are most volatile or unstable is called "Snif-fer".

Any sort of pattern recognition or predictive model can be used to initiate algo trading. Neural networks and genetic programming have been used to create these models. Pattern recognition is a field within the area of machine learning. ... // See also Artificial neural network. ... Genetic programming (GP) is an evolutionary algorithm based methodology inspired by biological evolution to find computer programs that perform a user-defined task. ...

“Now it’s an arms race,” said Andrew Lo, director of the Massachusetts Institute of Technology’s Laboratory for Financial Engineering. “Everyone is building more sophisticated algorithms, and the more competition exists, the smaller the profits.”^[9]

Issues and developments

More sophisticated models and intelligent programs have created the question of whether the models will break down.

“The downside with these systems is their black box-ness,” Mr. Williams said. “Traders have intuitive senses of how the world works. But with these systems you pour in a bunch of numbers, and something comes out the other end, and it’s not always intuitive or clear why the black box latched onto certain data or relationships.”^[10]

Regulators in Great Britain are watching the development of algo trading.

“The Financial Services Authority has been keeping a watchful eye on the development of black box trading. In its annual report the regulator remarked on the great benefits of efficiency that new technology is bringing to the market. But it also pointed out that ‘greater reliance on sophisticated technology and modelling brings with it a greater risk that systems failure can result in business interruption’.”^[11]

Other issues include the technical problem of latency or the delay in getting quotes to traders,^[12] security and front running, and the possibility of a complete system breakdown leading to a market crash.^[13] Latency is a time delay between the moment something is initiated, and the moment one of its effects begins. ... Front Running is the unethical practice of a broker trading an equity based on information from the analyst department before his or her clients have been given the information. ... Black Monday (1987) on the Dow Jones Industrial Average A stock market crash is a sudden dramatic decline of stock prices across a significant cross-section of a stock market. ...

The cost of developing and maintaining algorithms is still relatively high, especially for new entrants, as the need for stability, bandwidth and speed is even higher than for regular order execution. Firms which have not developed their own algorithmic trading have had to buy competing firms.

For example Citigroup paid $680 million in July 2007 for Automated Trading Desk, a 19 year old firm that trades about 200 million shares a day, accounting for about 6 percent of trading volume in U.S. markets.^[14] Citigroup had previously bought Lava Trading and OnTrade Inc. Analyst Richard Bove of Punk, Ziegel & Co. said that it would still take Citigroup several years to catch up to its largest competitors. Citigroup Inc. ...

"Goldman spends tens of millions of dollars on this stuff. They have more people working in their technology area than people on the trading desk .... The nature of the markets has changed dramatically."^[15]

Financial market news is now being formatted by firms such as Reuters, Dow Jones, Bloomberg, and Thomson Financial, to be read and traded on via algorithms. Reuters Group plc (LSE: RTR and NASDAQ: RTRSY); pron. ... Dow Jones & Company NYSE: DJ, based in the United States, is a publishing and financial information firm. ... Bloomberg L.P. is a Financial Media Company founded by Michael Bloomberg in 1982. ... Thomson Financial is an arm of The Thomson Corporation, one of the worlds leading information companies, focused on providing integrated information solutions to business and professional customers. ...

“Computers are now being used to generate news stories about company earnings results or economic statistics as they are released. And this almost instantaneous information forms a direct feed into other computers which trade on the news.”^[16]

The algorithms do not simply trade on simple news stories but also interpret more difficult to understand news.

“There is a real interest in moving the process of interpreting news from the humans to the machines” says Kiristi Suutani, global business manager of algorithmic trading at Reuters. “More of our customers are finding ways to use news content to make money.”^[17]

Effects

Though its development may have been prompted by decreasing trade sizes caused by decimalization, algorithmic trading has reduced trade sizes further. Jobs once done by human traders are being switched to computers. The speeds of computer connections, measured in milliseconds, have become very important. ^{[18] [19]} One millisecond is one-thousandth of a second. ...

More fully automated markets such as NASDAQ have gained market share from less automated markets such as the NYSE. Economies of scale in electronic trading have contributed to lowering commissions and trade processing fees, and contributed to international mergers and consolidation of financial exchanges. In economics a financial market is a mechanism that allows people to easily buy and sell (trade) financial securities (such as stocks and bonds), commodities (such as precious metals or agricultural goods), and other fungible items of value at low transaction costs and at prices that reflect efficient markets. ...

Competition is developing among exchanges for the fastest processing times for completing trades. For example the London Stock Exchange, in June 2007, started a new system called TradElect, which promises an average 10 millisecond turnaround time from placing an order to final confirmation, and can process 3,000 orders per second.^[20] The Source by Greyworld, in the new LSE building Paternoster Square. ...

Spending on computers and software in the financial industry increased to $26.4 billion in 2005.^[21]

Brokers have found it more difficult to monitor the risk of their clients' positions, especially for clients such as hedge funds.

See also

• Artificial Intelligence
• Complex Event Processing
• Electronic trading
• High frequency computing
• Implementation shortfall
• Investment strategy
• Quantitative trading

Garry Kasparov playing against Deep Blue, the first machine to win a chess game against a reigning world champion. ... It has been suggested that this article or section be merged into Event Stream Processing. ... Electronic trading is a mode of trading that uses information technology to bring together a buyer and a seller through electronic media to create a virtual market place. ... High frequency computing is a class of computer programming applications that relate to the processing of high-volume data streams, usually in real-time or near real-time. ... Definition Implementation Shortfall is the difference between the decision price and the final execution price (including commissions, taxes, etc. ... An investment strategy is a set of guidlines, behaviors or procedures designed to maximize overall return for an individuals investment portfolio. ... A quantitative analyst is a person who works in the financial markets developing mathematical models to assist the activities of traders and risk managers within banks and other large corporate institutions. ...

References

The Wall Street Journal Europe is a version of The Wall Street Journal with daily news and analysis of global business developments for a European audience. ... The Wall Street Journal Europe is a version of The Wall Street Journal with daily news and analysis of global business developments for a European audience. ...

External links

• Automated Trader Magazine: glossary of algorithmic trading terminology
• Business Week, Cracking the Street's New Math, April 18, 2005
• Outlook On Electronic Trading published by TABB Group, January 2006
• Paper on the empirical efficiency of combining algorithmic trading strategies
• FT Mandate Special Report on Algorithmic Trading